What it is:
How it works/Example:
Typically, these securities move sharply higher when the economy is expanding. However, they also tend to lose value as economic conditions deteriorate. Although this concept is true of most stocks, it is particularly evident when it comes to shares of companies that operate in highly cyclical industries.
Auto manufacturing and residential construction are examples of cyclical industries. Other cyclical groups include transportation, oil services and mining.
Why it matters:
Since cyclical stocks generally rise in good economic times and fall during bad times, investors attracted to cyclical stocks are faced with the arduous task of trying to time the market. This means they must try to predict where the bottom of the business cycle is in order to buy these stocks at the optimal time and then predict where the top of the cycle is in order to sell at the optimal time.
Regardless, timing the market can be hard, given the fact that some cyclical stocks start bouncing back before a recession is actually over. Holding the stock of companies in cyclical industries over the long-term is therefore a somewhat controversial issue because economic downturns can take years to recover from.