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To achieve financial freedom and grow wealth over long periods of time, it’s vital to understand the concept of inflation.

Inflation refers to the ever-increasing price of goods and services as measured against a particular currency. The purchasing power of a currency depreciates as a result of rising prices. Put differently, a rising rate of inflation equates to a decreasing value of a currency.

Inflation is most commonly measured by the Consumer Price Index (CPI), which averages the national cost of many consumer items such as food, housing, healthcare, and more.

The opposite of inflation is deflation, which happens when prices fall. During deflation, cash becomes the most valuable asset because it can buy more. During inflation, other assets become more valuable than cash because it takes more currency to purchase them.

The key question to examine is: What assets perform the best during inflationary times?

This is a much-debated topic among investment analysts and economists, with many differing opinions. And while there may be no single answer to that question, there are still some generally agreed upon concepts that can help to inform investors on the subject.

Is Inflation Good or Bad for Investors?

Depending on an individual’s perspective, inflation might be seen as either good or bad.

For the average person who tries to save money without investing much, inflation could generally be seen as negative. A decline in the purchasing power of the saver’s currency leads to them being less able to afford things, ultimately resulting in a lower standard of living.

For wealthier investors who hold a lot of financial assets, however, inflation might be perceived in a more positive light. As the prices of goods and services rise, so do financial assets. This leads to increasing wealth for some investors. And because currencies always depreciate over the long-term, those who hold a diversified basket of financial assets for long periods of time tend to realize significant returns.

It’s generally thought that there is a certain level of inflation that contributes to a healthier economy by encouraging spending without damaging the purchasing power of the consumer. The idea is that when there is just enough inflation, people will be more likely to spend some of their money sooner, before it depreciates, leading to an increase in economic growth.

When there is too much inflation, however, people can wind up spending most of their income on necessities like food and rent, and there won’t be much discretionary income to spend on other things, which could restrict economic growth.

Central banks like the Federal Reserve try to control inflation through monetary policy. Sometimes their policies can create inflation in financial assets, like quantitative easing has been said to do.

5 Tips for Hedging Against Inflation

The concept of inflation seems simple enough. But what might be some of the best ways investors can protect themselves?

There are a number of different strategies investors use to hedge against inflation. The common denominators tend to be hard assets with a limited supply and financial assets that tend to see large capital inflows during times of currency devaluation and rising prices.

Here are five tips that may help investors hedge against inflation.

1. Real Estate Investment Trusts (REITs)

A Real Estate Investment Trust (REIT) is a company that deals in real estate, either through owning, financing, or operating a group of properties. Through buying shares of a REIT, investors can gain exposure to the assets that the company owns or manages.

REITs are income-producing assets, like dividend-yielding stocks. They pay a dividend to investors who hold shares. In fact, REITs are required by law to distribute 90% of their income to investors.

Holding REITs in a portfolio might make sense for some investors as a potential inflation hedge because they are tied to a hard asset—real estate. During times of high inflation, hard assets tend to rise in value against their local currencies because their supply is limited. There will be an ever-increasing number of dollars (or euros, or yen, etc.) chasing a fixed number of hard assets, so the price of those things will tend to go up.

Owning physical real estate—like a home, commercial complex, or rental property—also works as an inflation hedge. But most investors can’t afford to purchase or don’t care to manage such properties. Holding shares of a REIT provides a much easier way to get exposure to real estate.

2. Bonds and Equities

The recurring theme regarding inflation hedges is that the price of everything goes up. What investors are generally concerned with is choosing the assets that go up in price the fastest, with the greatest possible return.

In some cases, it might be that stocks and bonds very quickly rise very high in price. But in an economy that sees hyperinflation, those holding cash won’t see their investment, i.e., cash, have the purchasing power it may have once had.

In such a scenario, the specific securities aren’t as important as making sure that capital gets allocated to stocks or bonds in some amount, instead of holding all capital in cash.

3. Exchange-Traded Funds

An exchange-traded fund (ETF) that tracks a particular stock index or group of investment types is another way to get exposure to assets that are likely to increase in value during times of inflation and can also be a strategy to maximize diversification in an investor’s portfolio. ETFs are generally passive investments, which may make them a good fit for those who are new to investing or want to take a more hands-off approach to investing. Since they are considered a diversified investment, they may be a good hedge against inflation.

4. Gold and Gold Mining Stocks

For thousands of years, humans have used gold as a store of value. Although the price of gold or other precious metals can be somewhat volatile in the short term, few assets have maintained their purchasing power as well as gold in the long term. Like real estate, gold is a hard asset with limited supply.

Still, the question of “is gold a hedge against inflation?” has different answers depending on whom you ask. Some critics claim that because there are other variables involved and the price of gold doesn’t always track inflation exactly, that it is not a good inflation hedge. And there might be some circumstances under which this holds true.

During short periods of rapid inflation, however, there’s no question that the price of gold rises sharply. Consider the following:

•  During the time between 1970 and 1974, for example, the price of gold against the US dollar surged from $240 to more than $900 for a gain of 73%.
•  During and after the recession of 2007 to 2009, the price of gold doubled from less than $1,000 in November 2008, to $2,000 in August 2011.
•  In 2019 and 2020, gold has hit all-time record highs against many different fiat currencies.

Investors seeking to add gold to their portfolio have a variety of options. Physical gold coins and bars might be the most obvious example, although these are difficult to obtain and store safely.

5. Better Understanding Inflation in the Market

Ultimately, no assets are 100% protected from inflation, but some investments might be better than others for some investors. Understanding how inflation affects investments is the beginning of growing wealth over time and achieving financial goals. Still have questions about hedging investments against inflation? SoFi credentialed financial planners are available to answer questions about investments at no additional cost to members.

Downloading and using the stock trading app can be a helpful tool for investors who want to stay up to date with how their investments are doing or keeping an eye on the market in general.

Learn more about how the SoFi app can be a useful tool to reach your investment goals.

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External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, LLC and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

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It can be daunting to sit down and try to learn even just the basics about the stock market—for example, it might be downright revelatory to learn that there is no all-encompassing “stock market,” but instead many stock exchanges and markets. Rather than trying to absorb everything in one go, a good crash course that can help newcomers wanting to be better informed about the topic side-step a lot of minutiae of the alphabet soup (NASDAQ, NYSE, DJIA, etc.) starts with a good look at the S&P 500.

For further context, here’s SoFi’s guide on how stock exchanges work in general.

Who is Standard & Poor’s Anyway?

Standard & Poor’s is a financial services company specializing in conducting research and analysis that helps investors recognize opportunities and make better, more informed decisions. The company’s roots date back to 1860 with the publication of a book of financial information on the US railroad industry—which is only worth mentioning and being aware of in the 21st century as an indication of how steeped the company is in its mission to help provide transparency into the world of investing.

A History of the S&P 500: 1957 – Now

The S&P 500 was first introduced in 1957, the result of ongoing and gradual expansions to S&P’s previous, comparatively more limited stock indexes—like 1926’s roll-out of a daily round-up of 90 stocks. Its emergence in 1957, according to S&P’s official history, was made possible by “an electronic calculation method developed by Boston-based Melpar, Inc., that allowed S&P to perform index calculations much more efficiently than before.” And while S&P reportedly could have tracked every stock on the New York Stock Exchange, it was decided to instead limit its scope to stocks that account for over 90% of total US market value. (When it began, the S&P 500 consisted of 425 industrial companies, 25 railroad companies, and 50 utility companies.)

A big reason why the S&P 500 is today widely considered by many investors to be perhaps the single best overall indicator of how large US stocks are performing is because of, as the name suggests, how comprehensive this index is. The S&P 500 is comprised of 500 large-cap stocks (meaning a company valued at being worth more than $10 billion) representing the leading industries of the US economy, including everything from healthcare and information technology to utilities and many more. The S&P 500 tracks both the liquidity (how easily their stock can be purchased) and also the risk associated with those companies.

Altogether, the S&P 500 gives an overview of how larger companies are performing, and as a result how many investor portfolios are performing as well. Through mutual funds or exchange-traded funds, it’s possible to participate as an investor in these large companies. SoFi’s financial planners can advise interested investors on what might make sense for your situation.

While on paper the S&P 500 is by a great measure more comprehensive than the Dow Jones Industrial Average (which measures the stock performance of only 30 large companies listed on stock exchanges), it should also be noted that a handful of the S&P 500 either are incorporated in or have headquarters located in other countries, like manufacturer Trane Technologies (Ireland) or oil and gas company TechnipFMC (England). In other words, while the S&P 500 can give a solid overview of how large American companies are performing, it’s also an international index. To learn more about index investing and building a portfolio bigger than what might be right in your backyard, this overview on index investing is worth a look.

S&P 500 Earnings History

A quick look at the S&P 500 price history’s biggest milestones only further bolsters its potential usefulness as a market indicator for investment decisions. To start with the bummer news and get it out of the way first, consider some of the lowest performances tracked and posted by the S&P 500: The stock market crash of 2008, for example, saw the market close at 903.25, with a point loss of 565.10 and overall being down 38.49%. The stock market crash of 1931, part of the Great Depression, was even worse, with Standard & Poor’s clocking a closing level of 8.12, a point loss of 7.22 and the market being down 47.07%.

In contrast, and maybe not a surprise, when the United States pulled out of the Great Depression in 1933 stands among some of the biggest high points in this country’s earnings history: That year S&P clocked the market surge ahead by 46.59%, closing at 10.10 and a point increase of 3.21. More recently, March 13, 2020 saw the market close at a record closing level of 2,711.02, representing a 230.38 point change and a 9.29% jump.

As that recent date and activity suggests, while things are getting more volatile nationwide with COVID-19 with massive layoffs, unemployment claims, and uncertainty about when the economy will reopen, the markets are being shaken up quite a bit: Just 10 days after that previously cited higher point, on March 23, 2020 the S&P 500 closed at 2,237.4. On April 17, 2020 it had already bumped back up to 2,874.56.

But if there’s anything that can make eyes gloss over more than alphabet soup it’s a wall of numbers. All these figures really mean is that the S&P 500 is regarded as one of the leading authorities in gauging how the US is doing financially.

Getting Started

SoFi has a team of credentialed financial advisors available to answer investors’ questions and help them reach their goals. Whether they’re interested in choosing individual stocks or trying an index fund, it’s important for investors to keep track of their portfolio and current market trends.

Talk with a financial planner today to get started investing with SoFi Invest®

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SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, LLC and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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Momentum trading is a type of short-term, high-risk trading strategy that requires a lot of skill and practice. While momentum trades can be held for longer periods when trends continue, the term generally refers to trades that are held for a day or several days, on average.

Momentum traders strive to chase the market by identifying the trend in price action of a specific security and extract profit by predicting its near-term future movement.

Looking for a good entry point when prices fall and then determining a profitable exit point when prices become overbought is the method to momentum trading madness. Momentum trading can also involve using various short strategies to profit from market downturns.

In a sense, this kind of trading is that simple. But of course, things can be much more difficult in practice. If it were easy, then everyone would do it.

The fact of the matter is this—the vast majority of individuals who attempt short-term trading strategies like this are not successful.

History of Momentum Trading

Momentum trading is a relatively new phenomenon. This kind of trading style has been made much more readily accessible with modern technology that makes trading easier in general.

An investor named Richard Driehaus has sometimes been referred to as “the father of momentum trading.” His strategy was at odds with the old stock market mantra of “buy low, sell high.”

Driehaus theorized that more money could be made by buying high and then selling at even higher prices. This idea aligns with the overarching theme of following a trend.

During the late 2000s as computers got faster, many different varieties of this type of trading began to spring up. Some of them were driven by computer models, sometimes trading on very small timeframes.

High-frequency trading algorithms, for example, can execute hundreds of trades per second. With this type of trading, humans don’t actually do anything beyond managing the system. It’s believed that about 90% of all trades that occur on Wall Street today are executed by high-frequency trading bots.

Momentum trading has become more popular in recent years with the advent of digital brokerage accounts. There have also been a number of new investment vehicles created that are well-suited to this style of trading, such as certain exchange-traded funds (ETFs).

Ever since the widespread elimination of many commission fees back in Q4 2019, it’s possible that even more retail investors might be inclined to try their hand at momentum trading. Transaction costs and brokerage fees were also a very big disadvantage for short-term traders, as the fees could reduce profits by a wide margin.

Why are some people interested in this kind of trading? The answer is simple.

While the risks are high, so are the potential rewards.

How Momentum Trading Works

In essence, momentum trading involves picking a security (such as a stock or ETF), identifying a trend, and then executing a plan to capitalize on the trend based on the assumption that it will continue in the near-term.

There are many things that can be taken into consideration to this end. Among these are factors like volatility, volume, time, and technical indicators.

Volatility

Volatility refers to the size and frequency of price changes in a particular asset. Short-term traders tend to like volatility because wild market swings can create opportunities for large profits in short amounts of time. Of course, volatility also increases risk. In fact, one of the biggest indications that an asset has high risk is often that it has high volatility.

Recommended: Understanding Stock Volatility

Volume

Volume represents the quantity of units of a particular asset being sold and bought during a certain period (e.g., the number of shares of a stock or ETF). Traders need assets with adequate volume to keep their trades profitable. Without enough volume, traders can fall victim to something known as slippage.

Slippage occurs when there aren’t enough shares being sold at a trader’s price point to fulfill the order all at once. A trade then winds up being executed across multiple orders, each of them being slightly lower than the last, resulting in a smaller profit overall. When volume is high enough, this won’t happen, as most orders can be filled all at once at a single price point.

Time Frame

Having a plan is part of what separates successful traders from unsuccessful ones. As discussed, momentum trading usually takes place on a short time-frame, although not always as short as some day trading strategies. While day traders might hold a position for hours or even minutes, momentum traders might hold positions for a day, several days, or longer.

Technical Indicators

Technical analysis is the art of trying to predict future price movements by analyzing charts. Charting software provides traders with a long list of tools that use different mathematical formulas to indicate how the price of an asset has performed in a specific timeframe. These tools are referred to as technical indicators.

Based on one or more of these indicators, traders try to infer what the near future holds for a security. This process is far from perfect, and technical analysis might best be described as only slightly predictive. Still, it’s an important part of a short-term trader’s arsenal. What do these indicators look like?

One of the simplest technical indicators is called the Relative Strength Index (RSI). This indicator is supposed to chart the recent strength of a stock based on closing prices during a given period.

The RSI provides a simple numerical value on a scale from 0–100. The higher the value, the more overbought a security might be, while a lower value indicates a security might be oversold. In other words, a low RSI can be a buy signal, while a high RSI can be a sell signal.

The topic of technical analysis goes far beyond the scope of what can be covered here in this article. For a more detailed look at the subject, take a look at this SoFi resource.

Advantages of Momentum Trading

The main advantage of momentum trading is that it can be profitable in a relatively short amount of time when executed correctly and consistently.

Whereas buy-and-hold investors tend to wait months, years, or even decades before seeing significant profits, successful momentum traders have the potential to turn out profits on a weekly or daily basis.

While investing for the long-term requires a good understanding of the fundamental factors that go into each investment, momentum trading tends to be focused around technical analysis of charts.

While this method of trying to predict price movements is by no means infallible, it does keep things simple. Traders are focused through a single lens rather than trying to comprehend the bigger picture.

In this sense, momentum trading may be simpler. But compared to long-term investing, short-term trading involves a lot more buying and selling, and that creates additional opportunities to make mistakes.

Disadvantages of Momentum Trading

As mentioned, there are a lot of risks involved in momentum trading. Momentum traders try to make inferences about future price movement based on the recent actions of other market participants. This can work, but it can also be thrown off balance completely by a single press release or fundamental development.

For example, imagine a momentum trader identifies a strong upward trend in a stock of a telecommunications company we will call Company A.

This imaginary trader develops a plan and begins executing it, placing a buy order at a select price point when the stock dips. The plan is to sell once the stock reaches a long-term resistance level that was established months ago, let’s say.

Our hypothetical trader has done this same trade before many times and made a nice profit each time, so she thinks this time will be no different.

But then something unexpected happens. The next trading day, when profits were to be booked on a continued rising price trend, a rival telecommunications company, Company B, issues a press release.

Company B has pulled ahead of Company A, implementing a new technology that will benefit customers greatly. As a result, investors begin selling stock in company A, expecting them to lose customers to competitors like Company B.

In this imaginary case, any trends that might have been identified using technical analysis would have been invalidated quickly. Hypothetical scenarios like this play out every day in the real markets.

Tax Implications to Know

Those interested in momentum trading or other short-term trading strategies may want to review the tax implications associated with this style of trading. It can be worth reviewing how taxes will impact an investor, since they could take a chunk of an investor’s profits.

Know that the IRS makes a distinction between traders and investors, for tax purposes, and it’s important to understand where you fall. A trader is someone considered by law to be in the investment business while an investor is someone buying and selling securities for personal gain.

The IRS also differentiations between short-term and long-term investments when evaluating capital gains and losses. In general, long-term investments are those held for a year or more, while those held for less than a year are considered short-term investments. Long-term investments may benefit from a lower tax rate, while short-term capital gains are taxed at the same rate as ordinary income.

Another rule worth understanding is the wash sale rule . While some capital losses can be taken as a tax deduction, there are certain regulations in place to stop investors from taking advantage of this benefit. The wash sale rule restricts investors from benefiting from selling a security at a loss and then buying a substantially identical security within 30 days. A wash sale occurs if you sell a security and then your spouse or a corporation under our control buys a similar security within the 30 day period following the sale.

Investing With SoFi

Now you have some answers to the question, “what is momentum trading?”

In short, it involves a combination of techniques that attempt to predict and take advantage of short-term market fluctuations. This skill is hard to master, requires a lot of knowledge and experience, and carries high risk. This kind of trading is not for everyone.

No matter what kind of trading you’re into, the SoFi Invest® provides all the tools needed to get started.

Download the SoFi app to keep up with the latest market news and start investing today.

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SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, LLC and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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