Cyclical stocks are stocks that tend to follow trends in the broader economic cycle, with returns fluctuating as the market moves through upturns and downturns. A cyclical stock is the opposite of a defensive stock, which tends to offer more consistent returns regardless of macroeconomic trends.
Investing in cyclical stocks could be rewarding during periods of economic prosperity. During a recession, however, certain types of cyclical stocks may be affected if consumers are spending less.
Key Points
• Cyclical stocks may align with economic trends, offering higher returns during periods of growth.
• Cyclical stock investments may represent discretionary items that consumers may be less likely to purchase when the economy slows.
• Travel, retail, and entertainment are examples of cyclical sectors.
• Defensive stocks may provide more stable returns independent of economic trends, contrasting with cyclical stocks.
• Cyclical stocks can be subject to uneven short-term returns, but may offer long-term appreciation.
What Is a Cyclical Stock?
A cyclical stock is a stock that may perform differently depending on what part of the market cycle the stock market is in at a given time. These types of stocks tend to overlap with the broader economic cycle. As such, the stock market is not static; it moves in cycles that often mirror the broader economy. To understand cyclical stocks, it helps to understand how the market changes over time, with the understanding that this has a different impact on different types of stocks.
A single stock market cycle involves four phases:
Accumulation (trough)
After reaching a bottom, the accumulation phase signals the start of a bull market and increased buying activity among investors.
Markup (expansion)
During the markup phase more investors may begin pouring money into the market, pushing stock valuations up.
Distribution (peak)
During this phase, investors begin to sell the securities they’ve accumulated, and market sentiment may begin to turn neutral or bearish.
Markdown (contraction)
The final phase of the cycle stock is a market downturn, when prices begin to significantly decline until reaching a bottom, at which point a new market cycle begins.
Cyclical Stocks Examples
The cyclicality of a stock depends on how they react to economic changes. The more sensitive a stock is to shifting economic trends, the more likely investors would consider it cyclical. Some of the most common cyclical stock examples include companies representing these industries:
Generally, consumer cyclical stocks represent “wants” versus “needs” when it comes to how everyday people spend. That’s because when the economy is going strong, consumers may spend more freely on discretionary purchases. When the economy struggles, consumers may begin to cut back on spending in those areas.
Cyclical Stocks vs Non-cyclical Stocks
Cyclical stocks are the opposite of non-cyclical or defensive stocks. Noncyclical stocks don’t necessarily follow the movements of the market. While economic upturns or downturns can impact them, they may be more insulated against negative impacts, such as steep price drops.
Non-cyclical stocks examples may include companies from these sectors or industries:
• Utilities, such as electric, gas and water
• Consumer staples
• Healthcare
Defensive or non-cyclical stocks represent things consumers are likely to spend money on, regardless of whether the economy is up or down. So that includes essential purchases like groceries, personal hygiene items, doctor visits, utility bills, and gas. Real estate investment trusts that invest in rental properties may also fall into this category, as recessions generally don’t diminish demand for housing.
Cyclical stocks may see returns shrink during periods of reduced consumer spending. Defensive stocks, on the other hand, may continue to post the same, stable returns or even experience a temporary increase in returns as consumers focus more of their spending dollars on essential purchases.
There are several reasons to consider investing in cyclical stocks, though whether it makes sense to do so depends on your broader investment strategy. Cyclical stocks are often value stocks, rather than growth stocks. Value stocks are undervalued by the market and have the potential for significant appreciation over time. Growth stocks, on the other hand, grow at a rate that outpaces the market average.
If you’re a buy-and-hold investor with a longer time horizon, you may consider value cyclical stocks. But it’s important to consider how comfortable you are with investment risk and riding out market ups and downs to see eventual price appreciation in your investment. When considering cyclical stocks, here are some of the most important advantages and disadvantages to keep in mind.
Some potential advantages of investing in cyclical stocks include the following.
• Return potential. When a cyclical stock experiences a boom cycle in the economy, that can lead to higher returns. The more money consumers pour into discretionary purchases, the more cyclical stock prices may rise.
• Predictability. Cyclical stocks often follow market trends, making it potentially easier to forecast how they may react under different economic conditions. This could be helpful in deciding when to buy or sell cyclical stocks in a portfolio.
• Value. Cyclical stocks may be value stocks, which can create long-term opportunities for appreciation. This assumes, of course, that you’re comfortable holding cyclical stocks for longer periods of time.
Cons of Cyclical Stocks
Some potential disadvantages of investing in cyclical stocks include the following.
• Volatility. Cyclical stocks are by nature more volatile than defensive stocks. That means they could post greater losses if an unexpected market downturn occurs.
• Difficult to time. While cyclical stocks may establish their own pricing patterns based on market movements, it can still be difficult to determine how long to hold stocks. If you trade cyclical stocks too early or too late in the market cycle, you could risk losing money or missing out on gains.
• Uneven returns. Since cyclical stocks move in tandem with market cycles, your return history may look more like a rollercoaster than a straight line. If you’re looking for more stable returns, defensive stocks could be a better fit.
💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.
How to Invest in Cyclical Stocks
When considering cyclical stocks, it’s important to do the research before deciding which ones to buy. Having a basic understanding of fundamental analysis and technical analysis can help.
Fundamental analysis means taking a look under a company’s hood, so to speak, to measure its financial health. That can include looking at things like:
• Assets
• Liabilities
• Price-to-earnings (P/E) ratio
• Earnings per share (EPS)
• Price/earnings ratio (PEG ratio)
• Price-to-book ratio (P/B)
• Cash flows
Fundamental analysis looks at how financially stable a company is and how likely it is to remain so during a changing economic environment.
Technical analysis, on the other hand, is more concerned with how things like momentum can affect a stock’s prices day to day or even hour to hour. This type of analysis considers how likely a particular trend is to continue.
Considering both can help you decide which cyclical stocks may be beneficial for achieving your short- or long-term investment goals.
The Takeaway
Cyclical stocks are stocks that tend to follow trends in the broader economic cycle, with returns fluctuating as the market moves. Cyclical stocks could be a good addition to your portfolio if you’re interested in value stocks, or you want to diversify with companies that may offer higher returns in a strong economy.
Investing in cyclical stocks does have its pros and cons, however, like investing in just about any other type or subset of securities. Investors should make sure they know the risks, and consider talking to a financial professional before making a decision.
Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.
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FAQ
What are the four cycles of the stock market?
The market generally moves through four cycles: Accumulation, markup, distribution, and markdown, which may also be called trough, expansion, peak, and contraction. Note that it may take years for a single market cycle to complete.
What is the definition of “cyclical stock?”
Cyclical stocks are stocks that tend to follow trends in the broader economic cycle, with returns fluctuating as the market moves.
What are some examples of cyclical stocks?
Cyclical stocks may be shares of companies in industries such as travel and tourism, restaurants and food service, certain facets of manufacturing, retail, entertainment, or construction.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
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SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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Most investors are familiar with ordinary exchange-traded stocks, but there’s another equity category known as over-the-counter stocks (OTC) — which aren’t necessarily available on public exchanges like the New York Stock Exchange (NYSE) or Nasdaq.
Rather, OTC stocks are traded through a broker-dealer network, known as OTC markets — which can include other types of securities, as well. The Financial Industry Regulatory Authority (FINRA) oversees broker-dealers that engage in OTC trading, but in general OTC markets are less transparent, and less regulated than public exchanges.
OTC stocks may include companies that are too small to trade on public exchanges, as well as some types of foreign securities, bonds, and derivatives.
Key Points
• Over-the-counter stocks are generally not available to trade on public exchanges, but some can be traded OTC as well as being listed on a national exchange.
• OTC stocks are traded through broker-dealer networks, also called OTC markets or Alternative Trading Systems (ATS).
• OTC markets are not limited to OTC stocks, but may include other types of securities: e.g., derivatives, corporate bonds, forex, and more.
• Certain OTC companies may be too small, or may not meet the criteria to trade on public exchanges.
• OTC markets tend to be less regulated than the public markets, and therefore less transparent, which can increase the risk of OTC trading.
What Are OTC Stocks?
As mentioned, an OTC stock is one that trades outside of a traditional public stock exchange. Although some OTC stocks may be available to trade either way.
Some OTC-traded stocks are exchange-listed, and some are unlisted (because they may not meet the criteria for the exchange).
A public stock exchange — like NYSE or Nasdaq — is a closely regulated environment in which buyers and sellers can trade shares of publicly listed companies. Before a stock can be listed on an exchange for public trading, it first has to meet the guidelines established by that exchange.
Companies may opt to trade shares in the over-the-counter market (meaning, they trade through a broker-dealer which typically relies on an Alternative Trading System, or ATS, to place trades) if they’re unable to meet the listing requirements of a public exchange. OTC trading may also appeal to companies that were previously traded on an exchange but were later delisted.
How to Buy OTC Stocks
Investors interested in purchasing OTC stocks may not need to change their investing strategy much, because depending on the exchange or platform they use to buy listed investments, they may be able to buy OTC stocks in much the same way.
Again, this will largely depend on the platform being used, but many — but not all — exchanges or platforms allow investors to trade OTC stocks. This can be done by searching for the OTC stock on the platform and placing an order. Investors may need to know the specific stock ticker they’re looking for, however, so there may be a bit of initial homework involved.
Types of OTC Securities
OTC trading tends to focus on equities, i.e. stocks.
One common type of stock available OTC is penny stocks, which tend to be higher risk. These small- or even micro-cap companies have less transparency because they don’t have to meet certain requirements for public exchanges. In addition, they tend to trade at low volumes, which makes these shares less liquid, and contributes to volatility.
But stocks don’t make up the entirety of OTC trading activity. Other types of investments that can be traded OTC include:
Altogether, there are thousands of securities that trade OTC. These can include small and micro-cap companies, large-cap American Depositary Receipts (ADRs), and foreign ordinaries (international stocks that are not available on U.S. exchanges).
Companies that trade over the counter may report to the SEC, though not all of them do.
Types of OTC Markets
In the U.S., the majority of over-the-counter trading takes place on networks operated by OTC Markets Group.
This company runs the largest OTC trading marketplace and quote system in the country (the other main one is the OTC Bulletin Board, or OTCBB). While companies that trade their stocks on major exchanges must formally apply and meet listing standards, companies quoted on the OTCBB or OTC Markets do not have to apply for listing or meet any minimum financial standards.
OTC Markets Group organizes OTC stocks and securities into three distinct markets:
• OTCQX
• OTCQB
• Pink Sheets
OTCQX
OTCQX is the first and highest tier, and is reserved for companies that provide the most detail to OTC Markets Group for listing. Companies listed here must be up-to-date with regard to regulatory disclosure requirements and maintain accurate financial records.
Penny stocks, shell corporations, and companies that are engaged in a bankruptcy filing are excluded from this grouping. It’s common to find stocks from foreign companies (e.g. foreign ordinaries) listed here.
OTCQB
The middle tier is designed for companies that are still in the early to middle stages of growth and development. These companies must have audited financials and meet a minimum bid price of $0.01. They must also be up-to-date on current regulatory reporting requirements, and not be in bankruptcy.
Pink Sheets
The Pink Sheets or Pink Open Market has no minimum financial standard that companies are required to meet, nor do they have reporting or SEC registration requirements. These are only required if the company is listed on a Qualified Foreign Exchange.
Be forewarned: OTC Markets Group specifies that the Pink Market is designed for professional and sophisticated investors who have a high risk tolerance for trading companies about which little information is available.
Pros and Cons of OTC Trading
Investing can be risky in general, but the risks may be heightened with trading OTC stocks. But trading higher risk stocks could result in bigger rewards if they deliver above-average returns.
When considering OTC stocks, it’s important to understand how the potential positives and negatives may balance out — if at all. It’s also helpful to consider your personal risk tolerance and investment goals to determine whether it makes sense to join the over-the-counter market.
Trading OTC Stocks: Pros and Cons
OTC Stock Trading Pros
OTC Stock Trading Cons
Over-the-counter trading may be suitable for investors who are interested in early stage companies that have yet to go public via an IPO.
Micro-cap stocks and nano-cap stocks that trade OTC may lack a demonstrated performance track record.
Investing in penny stocks can allow you to take larger positions in companies.
Taking a larger position in a penny stock could amplify losses if its price declines.
OTC may appeal to active traders who are more interested in current pricing trends than fundamentals.
Limited information can make it difficult to assess a company’s financials and accurately estimate its value.
OTC trading makes it possible to invest in foreign companies or companies that may be excluded from public exchanges.
OTC securities are subject to less regulation than stocks listed on a public exchange, which may increase the possibility of fraudulent activity.
OTC stocks may be more illiquid than stocks traded on a public exchange, making it more difficult to change your position.
The Takeaway
OTC stocks are those that trade outside of traditional exchanges like the NYSE or Nasdaq, and rely on a network of broker-dealers to conduct trades. The OTC market gives you access to different types of securities, including penny stocks, international stocks, derivatives, corporate bonds, and even cryptocurrency.
If you’re interested in OTC trading, the first step is to consider how much risk you’re willing to take on, and how much money you’re willing to invest when trading stocks. Having a baseline for both can help you to manage risk and minimize your potential for losses.
Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.
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FAQ
How do OTC stocks differ from stocks listed on major exchanges?
OTC stocks aren’t listed on major U.S. stock exchanges. They can still be traded via broker dealer networks; but how they’re listed (or not listed) is the primary differentiator.
How can I buy or sell OTC stocks?
Many investors can use their preferred brokerage or platform to buy and sell OTC stocks. Not all brokerages or investment platforms allow investors to do so, but many do, and trading them often involves searching for the appropriate ticker and executing a trade.
Are there any specific regulations or reporting requirements for OTC stocks?
There are reporting standards for OTC stocks, but those standards are not as stringent as listed stocks. Depending on the OTC market on which an OTC stock trades, more or less reporting may be required.
What are the main factors to consider when researching OTC stocks?
Investors should consider many factors in the OTC market, but among them are volatility, liquidity and trading volume, and applicable regulations. These three factors may have the biggest impact on how an OTC stock performs going forward, though that’s not guaranteed.
Are there any restrictions or limitations on trading OTC stocks?
The OTC markets don’t usually come with many restrictions. But public exchanges, brokerages, or platforms might not permit investors to trade OTC stocks or securities. In that case, investors can look for another platform on which to execute trades that does allow OTC trading.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
Photo credit: iStock/JohnnyGreig
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SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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Before a private company can make its shares available to the public for investment, it must go through the initial public offering (IPO) process. The IPO process is time-consuming, expensive, and it can take months or even years for a privately held company to reach the stage where it can be listed and traded on a public exchange.
An IPO marks the first time individuals other than angel investors or venture capitalists can make investments in a company. Once the initial public offering process is complete, traders can buy or sell shares in the company through a public exchange like the New York Stock Exchange or Nasdaq.
From an investor standpoint, getting in on the ground floor of a new initial public offering might be appealing if you think the company has the potential to take off. This primer explains how the IPO process works step by step.
Key Points
• An initial public offering (IPO) is the process a private company goes through to make its shares available to the public for investment.
• Companies may choose to do an IPO to raise capital and increase visibility around their brand.
• Prior to an IPO, a company must select an underwriter to conduct due diligence and sign necessary contracts.
• The SEC must review and approve all documents before the company can launch its IPO.
• After the launch, the underwriter may take action to stabilize the share price to help ensure it doesn’t fall below the IPO price.
A Quick Refresher on IPOs
Again, IPO stands for initial public offering. If a company launches an IPO, it means that it’s only had private investors, such as angel investors, up to that point but it’s now ready to let other investors purchase shares. Under federal securities laws, this can’t happen until the company is properly registered with the Securities and Exchange Commission (SEC).
There are different reasons a company may choose to do an IPO, but it’s often used as a means of raising capital. The initial public offer process can also help raise visibility around a particular company’s brand, helping to fuel growth. It means that ownership of the company is transitioning from founders and a few early investors to a much larger group of individuals and organizations.
An IPO can help companies raise capital as an alternative to other methods, such as crowdfunding, which also involves raising funds from a pool of investors. But unlike an IPO, it doesn’t involve the buying or selling of shares in a company.
💡 Quick Tip: Access to IPO shares before they trade on public exchanges has usually been available only to large institutional investors. That’s changing now, and some brokerages offer pre-listing IPO investing to qualified investors.
How Does the IPO Process Work?
At a glance, the initial public offering process seems relatively simple: A private company makes its shares available to the public for the first time, hence why it’s often referred to as “going public.”
But the initial public offering process is more detailed and complex than that. There are specific steps that must take place to ensure that an IPO is completed in accordance with SEC regulations. The company, either on its own or while working with analysts and investors, must value the company and set an initial public offer.
After completing due diligence, the company can move forward with an IPO announcement and choose an IPO launch date. Investors can then review the IPO prospectus to determine whether they want to invest or not.
The entire IPO process can take six months to a year or even longer to complete. Aside from being time-consuming, it can also be costly, so companies must have some degree of certainty that the IPO will succeed before undertaking it.
7 Steps of the IPO Process
The IPO process takes time, and it’s important for all parties involved that the appropriate steps be followed. If something is missed or overlooked, that could put the success of a company’s initial public offering in jeopardy. Here are the steps they must go through:
1. Choosing an Underwriter
Before starting any of the other IPO process steps, a company first has to connect with a reputable IPO underwriter or group of underwriters. Again, these are investment banks that are registered with the SEC to offer underwriting services.
When choosing an underwriter, companies can consider a variety of factors, including:
• Reputation
• IPO track record
• Research quality
• Industry expertise
• Distribution (i.e., what type of investors the bank will be able to distribute the initial public offering to)
Companies may also weigh any prior relationship they have with a particular investment bank or banks when deciding which one(s) to use for underwriting.
2. Due Diligence
During the due diligence phase, the IPO underwriting team will conduct background research into the company and its upper management. This ensures that there are no surprises prior to or during the IPO launch that could affect share pricing.
At this step in the IPO process, the underwriter and the company will sign necessary contracts specifying the scope of services provided. The contract can take several structures:
• Firm Commitment: In this type of arrangement, the underwriter agrees to purchase the IPO and resell shares to the public. This guarantees that the company receives an agreed-upon amount of money.
• Best Efforts: With this type of agreement, the underwriter assents to selling shares to the best of its ability, though there’s no guarantee that all shares will sell.
• All or None: In an all or none or agreement, all shares of the IPO must be sold or the offering is canceled.
In some cases, a group or syndicate of underwriters can come together to oversee the IPO process and manage risk. Each bank in the syndicate can sign a contract with the company to sell part of the IPO.
The underwriters will also initiate the registration process with the SEC and complete supporting documents for the IPO. These might include:
• Engagement Letter: An engagement letter typically includes a clause stating what expenses the company will reimburse to the underwriter as well as the spread that’s used to pay the underwriter’s fees, typically 7% of proceeds.
• Letter of Intent: This letter outlines the underwriter’s commitment or obligations to the issuing company, the company’s statement of commitment to cooperate with the underwriter and an agreement to provide the underwriter with a 15% over allotment option.
• Underwriting Agreement: The underwriting agreement binds the underwriter to purchase shares from the issuing company at a specified price.
• Red Herring Document: A red herring document contains some of the same information about the IPO that’s included in the IPO prospectus, excluding the price and number of shares being offered.
• S-1 Registration Statement: This is the document that’s submitted to the SEC to register the IPO and it must include relevant information about the company that must be included in the prospectus, as well as additional details that are not made available to the public.
3. SEC Review and Roadshow
At this stage of the initial public offering process, the SEC will review all of the documents submitted for the registration. Meanwhile, the company and its underwriting team will prepare for the roadshow.
This IPO roadshow is effectively a marketing strategy in which the underwriters attempt to gauge interest in the IPO from institutional investors. This can help underwriters to set the IPO price and determine what number of shares to offer.
💡 Quick Tip: How do you decide if a certain online trading platform or app is right for you? Ideally, the online investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.
4. IPO Pricing
Once the SEC has approved the IPO, the next critical step is choosing an initial share price. In terms of how an IPO price is set, this can depend on a number of factors, including:
• Company valuation
• Anticipated demand for shares among investors
• Road show outcomes
• Market conditions
• How much capital the company hopes to raise
• The company’s reputation
Pricing is important because it can determine the success or failure of an IPO. Price an initial public offer too high and it may scare off investors; price it too low and the company may not reach its target goal for capital raised once shares go on the market.
5. Launch
Once an IPO has the SEC’s approval and the number and price of shares has been set, all that’s left to do is launch. The company or underwriters typically announce ahead of time when an IPO is set to list so interested investors can ready themselves to buy shares on that date.
6. Stabilization
Stabilization refers to the underwriter taking direct action to stabilize share prices once the IPO launches. This is something underwriters may do for up to 30 days (typically) after an initial public offering hits the market.
In essence, the underwriter can execute what’s known as a stabilizing bid during this period in an effort to support the stock’s price.
However, major investors and company insiders who owned shares before the company went public must continue to abide by SEC rules during this time. Specifically, they’re required to observe the IPO lock-up period rule. This rule prevents them from selling any shares they own in the company for a set time period after the IPO, typically 90 to 180 days. This keeps those investors from dumping their shares prematurely which could affect share prices.
7. Transition to Market Competition
In the final step in the IPO process, the underwriters take a backseat. Rather than relying on the prospectus to determine valuations, shareholders turn their attention to market movements instead. The underwriters can continue acting in an advisory role but at this point, they can no longer do anything to influence pricing.
What Parties Participate in the IPO Process?
It takes a team to successfully launch an IPO, and each member has a distinct role in the initial public offer process. The company is the star player that the team revolves around, with senior management typically taking the lead.
But an IPO also requires assistance from other professionals. Understanding who is involved and what they do can help with navigating the steps of the IPO process.
Investment Banks
One role of investment bankers, also called underwriters, is to effectively oversee and manage the initial public offer process. The underwriting team is responsible for performing some of the most important IPO steps, including:
• Preparing IPO documentation
• Conducting necessary due diligence
• Preparing marketing materials for distribution to investors
• Overseeing the sale of company stock through the IPO
The investment banks serving as underwriters can also help with determining the appropriate valuation of a business as part of the IPO process.
Securities and Exchange Commission (SEC)
Companies must register with the SEC before launching an initial public offering. The SEC must review and accept all documentation the company submits in reference to the IPO prior to shares being sold to the public.
Attorneys and Accountants
Attorneys and accountants work alongside underwriters during the initial public offer process to prepare the required documentation. Legal counsel may draft documents and manage the SEC filing, while accountants may prepare the financial statements that accompany the SEC registration paperwork.
Stock Exchange
Going public with an IPO means choosing an exchange through which traders can buy and sell stock. In the United States, this typically means the New York Stock Exchange (NYSE) or the Nasdaq.
These include both those who put money into the company prior to its going public, such as venture capitalists, and those who anticipate trading shares once the IPO launches.
Both institutional investors, such as hedge funds or mutual funds, and individual retail investors who are interested in owning shares, may participate in an IPO.
Buying IPO shares may seem desirable, and there has been a lot of hype in the media about IPO stock. But it’s important to remember that IPO stocks are typically high risk, and investors can lose money. That’s why many brokerages require that investors meet certain standards in order to be qualified to trade IPO shares.
Test your understanding of what you just read.
The Takeaway
The process of taking a company public through an IPO can be exciting, but it’s also a rigorous transition that requires a fledgling company to meet a series of criteria and pass through several stages before actually making its debut on a public exchange.
This process helps to ensure that the company has sound fundamentals, and is ready for public shareholder investment. While investing in IPOs has gotten a reputation as a way to make money quickly, it’s also a way investors can rapidly lose their investment, as IPOs are traditionally volatile. In addition, not all investors may qualify to trade IPO shares; check with your brokerage.
Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.
Invest with as little as $5 with a SoFi Active Investing account.
FAQ
What is an IPO and how does it work?
An IPO, or initial public offering, is when a company sells shares of its stock to the public for the first time on a stock exchange. Essentially, through an IPO, what was once a private company becomes a public one. Typically, a company starts the IPO process when it is worth a significant amount of money, has demonstrated a proven potential for making a profit, and has a strong enough governance structure to meet SEC listing regulations.
When a company goes public, the private share ownership becomes public ownership. At that point, investors who are qualified to trade IPO shares can start buying shares on the public market.
How long does an IPO process last?
The IPO process can last six months to more than a year. The time it takes is based on how prepared a company is with such things as financial disclosures and governance, how complex the transaction will be, the market conditions, and the time needed for regulatory filings and review by the Securities and Exchange Commission (SEC), among other factors.
Is investing in an IPO good or bad?
Investing in an IPO is not necessarily good or bad. However, investing in an IPO involves a high amount of risk. While some IPOs may offer a potential for a good return, other IPOs may be overvalued by market hype beyond their true worth, for example. In addition, some studies show that IPOs tend to underperform in the market in the years following their market debut. Investors should be aware that IPOs are speculative and high risk.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. This should not be considered a recommendation to participate in IPOs and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation. New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For more information on the allocation process please visit IPO Allocation Procedures.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Mutual Funds (MFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.
This article is not intended to be legal advice. Please consult an attorney for advice.
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Alternative investments exist outside of traditional asset classes like stocks, bonds, and cash. Alternatives include assets such as commodities, infrastructure, collectibles, real estate, cryptocurrency, and other securities that generally have a low correlation with traditional assets.
While alts are typically higher risk, they can add diversification to a portfolio, which may help mitigate risk long term.
Some alts may provide higher returns compared to stocks and bonds, as well as the opportunity to earn passive income. But again, these are higher-risk instruments that tend to be illiquid and opaque. In addition, alts are typically subject to more complicated tax treatment.
Key Points
• Alternative investments include assets other than stocks, bonds, and cash, such as collectibles, commodities, derivatives, real estate, private equity, venture capital, cryptocurrency, and more.
• Alternative investments may provide portfolio diversification, as they often have a low correlation with traditional asset classes.
• Alternative investments have the potential to generate higher risk-adjusted returns compared with traditional assets, though this also comes with higher risk.
• Alternative investments tend to be illiquid, not as transparent as other financial assets, and may include the risk of total loss.
• You can invest in alternative investments through mutual funds, ETFs, interval funds, REITs, MLPs, or by working with an experienced asset manager.
What Are Alternative Investments?
Alternative investments — commonly known as alts — are those that fall outside conventional investment categories such as stocks, bonds, and cash. Examples of alternative investments include a wide variety of securities, as well as tangible assets such as commodities, foreign currencies, cryptocurrency, real estate, art and collectibles, and more.
Alts typically have a lower correlation with traditional asset classes, meaning they tend to move independently of assets like stocks and bonds, and thus they may provide investment portfolio diversification.
Alts also have the potential to generate higher returns when compared to stocks and bonds, and some are structured to provide passive income to investors. But understanding what alternative investments are means knowing the fact that these are typically higher-risk assets, which can be illiquid, lightly regulated and opaque (meaning it’s harder to track the actual value of some types of alternatives).
Alts used to be accessible mainly to high net-worth and accredited investors, but now they’re available to a range of investors, including self-directed trading, thanks to the emergence of vehicles such as mutual funds and ETFs that include various alts and alternative strategies.
Often there is little public data available regarding price changes or asset appreciation or depreciation, making it difficult to assess historical performance.
💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alts through a mutual fund or ETF generally involves a low minimum requirement, making them accessible to retail investors.
Alternative investments, now for the rest of us.
Explore trading funds that include commodities, private credit, real estate, venture capital, and more.
What Are the Main Categories of Alternative Investments?
The following list encompasses some common types of alternative investments and alternative strategies available to investors today. Some alternative investment categories may lend themselves to thematic investing, as you’ll see here.
Real Assets
1. Real Estate
• Summary: You can invest in real estate by owning rental property, investing in commercial real estate, industrial real estate, healthcare facilities, and more. Investors can also invest in Real Estate Investment Trusts, or REITs, which offer dividend payouts.
• Pros and cons: Although real estate tends to hold its value over time, there are no guarantees, and markets can be volatile. In addition, properties can be vulnerable to a host of factors including business trends, land values, interest rate risk, climate risk, and more.
2. Farmland and Timberland
• Summary: Like many types of property, farmland and timberland tend to hold their value over time — as long as they remain productive. This type of property can be similar to commodities in that there is potential profit in the products that come from the land (e.g., produce and timber).
• Pros and cons: Owners of farmland can lease out the land to earn income, which can be profitable for investors. The potential downside of investing in farmland and timberland are the environmental and weather-related risks that can impact both the value of the land and its productivity.
3. Infrastructure
• Summary: Infrastructure refers to the physical structures that economies depend on: roads and highways, bridges and tunnels, energy pipelines, and more. Municipal bonds are one way to invest in infrastructure, as are some types of REITs (real estate investment trusts).
• Pros and cons: As a non-cyclical type of asset, infrastructure investments may offer the benefit of less exposure to market risk factors, steady cash flows, and low variable costs. The potential risks of infrastructure investments include political and environmental factors that can impact or delay the execution of a project.
4. Commodities (e.g., Gold, Oil, Grain)
• Summary: Commodities are raw materials that include agricultural products (e.g. grain, meat); precious metals such as gold, silver, copper; energy (including renewables), and more. Generally, investors participate in commodity trading using futures contracts, index funds, mutual funds, or ETFs.
• Pros and cons: Some investors consider commodities a good hedge against inflation. In addition, because commodities are tangible assets, these products tend to have an intrinsic value. However, commodities can suffer from any number of unexpected risk factors, from weather conditions to supply chain breakdowns and more.
• Summary: There are different types of private equity strategies. Some involve buying a significant stake in a private or public company, with the aim of restructuring it for greater profitability. Other strategies include venture capital investments in start-up or early stage organizations.
Because PE is a high-stakes endeavor, these opportunities are generally available to high net-worth and accredited investors. Now, however, retail investors can potentially invest in private equity funds through vehicles such as interval funds.
• Pros and cons: Private equity is considered a high-risk investment, but if a private company goes public or gets acquired, these investments may perform well. The risk with private equity investments is that these are often focused on distressed companies, with a complex track record.
6. Private Credit
• Summary: Private credit involves direct loans made to companies from non-bank entities. Private credit can be a more expensive way to borrow, but it can be faster for the companies needing capital; for investors it offers the potential for generally higher interest payments.
• Pros and cons: Private credit funds tend to see greater inflows when the stock market is underperforming, and they usually pay higher rates than conventional fixed income instruments. The risk here is that most PC funds offer only quarterly redemptions — so they’re quite illiquid — and they can be vulnerable to defaults.
7. Venture Capital
• Summary: Venture capital investing is considered a subset of private equity, as noted above. VC investors typically want to put capital into startups and other early stage companies that show growth potential.
While VC investing used to require substantial industry experience, and in some cases accredited investor status, today investors can buy a slice of startup or private companies, through equity crowdfunding platforms (which differ from traditional crowdfunding in that investors own equity in the company) and interval funds, a type of closed-end fund that typically focuses on illiquid and alternative assets.
• Pros and cons: VC investing can be risky because not only is your capital locked up for a longer period of time, if the company fails, investors may lose all of their money. On the other hand, if a startup does well, investors may see a significant profit.
• Summary: Works or art and other types of collectibles (e.g., wine, jewelry, antiques, cars, rare books) can be considered investments in that these objects may increase in value over time. But art and collectibles include an aspect of connoisseurship that can be rewarding as well. The potential for a personal reward is important, as the financial side of these assets is hard to predict.
For those without the means to acquire some of these valuables, it’s possible to invest in fractional shares of art, or in shares of an art-focused fund.
• Pros and cons: Investing in art or collectibles may provide a hedge against inflation or other market factors. That said, the price of upkeep, insurance, and maintenance of the actual items can be considerable. And while some pieces may gain value over time, art and collectibles are subject to changing trends and tastes. Fraud is another risk to consider.
9. Hedge Funds
• Summary: Hedge funds offer qualified investors access to alternative investing strategies, like arbitrage, leveraged trades, short-selling, and more, at a steep cost. Hedge funds aren’t as heavily regulated as other types of funds, so they’re able to make riskier investments and lean into aggressive strategies, with the goal of delivering outsized returns.
• Pros and cons: While hedge fund managers sometimes deliver a profit, they typically charge double-digit fees and require high investment minimums, often starting in the seven figures. In addition, most hedge funds are only open to accredited investors. Today, retail investors may be able to access mutual funds, ETFs, funds of funds, or other vehicles that employ hedge-fund-like strategies.
10. Foreign Currencies
• Summary: The foreign currency market, or forex, is an over-the-counter (OTC) global marketplace, which is the largest financial market in the world. It’s open 24/7, and thus highly liquid, allowing investors to trade currency pairs at all times. Most forex traders use leverage in order to trade currencies.
• Pros and cons: Currency trading is known for its volatility, and currency traders often make leveraged trades, assuming a high degree of risk. Retail investors may find it potentially less risky to invest via mutual funds, ETFs, foreign bond funds, and even certain types of CDs (certificates of deposit). That said, the underlying volatility of most currencies will influence the performance of these investments as well.
Cryptocurrency
• Summary: Cryptocurrency, such as bitcoin, ethereum, and countless others, are types of digital currencies that are maintained through blockchain technology, and are not subject to a centralized bank in the way that traditional currencies are.
First introduced in 2009, when bitcoin was created, crypto has proven to be highly volatile, subject to digital theft and fraud, and other risk factors. That said, many traders find the possibility of higher returns and less regulation appealing.
• Pros and cons: When crypto first started, traders either bought or earned digital coins via digital mining and staking processes specific to certain coins. Today, it’s possible to invest in crypto through exchange-traded products, or ETPs (similar to ETFs, but not as heavily regulated), as well as stock in companies that provide exposure to crypto-related products, such as mining equipment or blockchain technology.
While these new crypto investment products may provide retail investors with some protection versus buying cryptocurrencies outright on an unregulated crypto exchange, they are still vulnerable to all the potential risks crypto brings.
💡 Quick Tip: Newbie investors may be tempted to buy into the market based on recent news headlines or other types of hype. That’s rarely a good idea. Making good choices shouldn’t stem from strong emotions, but a solid investment strategy.
How Can You Access Alternative Investments?
As mentioned above, alternative investments used to be limited to institutional investors and high net-worth investors, but they’re now available to retail investors through mutual funds, ETFs, ETPs, and sometimes even through companies’ IRAs.
Once you’ve identified the types of alternative investments that would suit your goals, your risk tolerance, and your plan (e.g., you might prefer commodities to owning art), you can look for the types of investment vehicles that would help you buy into these alternative asset classes.
Through Publicly Traded Funds (ETFs and Mutual Funds)
If a certain type of alternative asset appeals to you, it’s likely you can gain exposure to it through a type of mutual fund, ETF, exchange-traded product, or other type of pooled investment fund.
These vehicles offer some diversification because they hold so many different investments. And because they fall under SEC and FINRA regulations, these products tend to be more liquid and more transparent in comparison to some alts themselves.
Through Real Estate Investment Trusts (REITs)
A popular way to access the real estate market is through real estate investment trusts (REITs). Buying shares of a REIT allows investors to gain exposure to many types of real estate without having to own the physical property. The REIT owns and maintains the property — whether an office park, health facility, storage units or other — collecting rental income (or mortgage interest).
Investors may benefit if the REIT gains value. In addition, REITs provide passive income because they are required to pay out 90% of their profits in the form of dividends.
Through Specialized Online Platforms
Because alts can be harder to access for many individual investors — owing to higher minimums or other restrictions — a number of specialized online platforms have emerged that offer retail investors exposure to certain types of alts.
Some platforms enable investments in art, for example via fractional art investing. Other sites may offer access to farmland investments, collectibles, fine wines, and other types of alternatives.
Note that investing in alts using specialized channels like these typically require higher minimums and many also come with liquidity restrictions.
What Are the Pros and Cons of Alternative Investments?
In sum, alternative investments are certainly worth considering given their potential advantages, but it’s important to keep in mind the possible disadvantages to make the best choices in light of your own goals and risk tolerance.
Potential Benefits of Alts (e.g., Diversification)
• May offer the potential for higher risk-adjusted returns.
• Are typically not correlated with traditional stock and bond markets, so they may help diversify a portfolio and mitigate risk.
• May have the potential to deliver passive income.
• Some alts may hedge against inflation or interest rate fluctuations.
• May appeal to an individual’s personal interests: e.g., art, wine, memorabilia.
Potential Risks of Alts (e.g., Illiquidity, High Fees)
• Are often higher risk, or can be subject to greater volatility.
• Can be less liquid than traditional investments due to limited availability of buyers and lack of a convenient market.
• Often limited to high net-worth and accredited investors.
• May have higher minimum investment requirements and higher upfront fees.
• May have less available public data and transparency about performance, making it difficult to determine a financial asset’s value.
Key Considerations When Investing in Alts
Alternative investments are complex, and while the risk may be worth the potential reward for some investors, there are some additional caveats to bear in mind about these assets.
How Are Alternative Investments Taxed?
Unlike conventional asset classes, which are typically subject to capital gains tax or ordinary income tax, alts can receive very different tax treatments, even when investing in these assets via a mutual fund or ETF.
When investing in alts, it’s wise to involve a professional to help address the tax-planning side of the equation.
What Role Should Alts Play in Your Portfolio?
Remember, because alts don’t generally move in sync with traditional asset classes, they may offset certain risk factors. And while alts come with risks of their own, including volatility and lack of transparency, within the context of your portfolio as a whole, alts, and funds that invest in alts, may enhance returns. Some alts can provide passive income as well as gains.
It’s important to know, however, that alternative investments are higher risk, tend to be more illiquid, and less transparent. As such, alts should typically only be one part of your portfolio to complement other assets. Deciding on the right percentage for you depends on your risk tolerance.
The Takeaway
Alternative investments have the potential for high returns and may offer portfolio diversification. The scope and variety of these investments means investors can look for one (or more) that suits their investing style and financial goals. Unlike more conventional investments, alts tend to be higher risk, more expensive, and subject to complex tax treatment.
It’s important to research and do due diligence on any alternative investment in order to make the best purchasing decisions and reduce risk. While some alternative investments are less accessible, others can be purchased through vehicles such as mutual funds and ETFs.
Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.
Invest in alts to take your portfolio beyond stocks and bonds.
FAQ
Are ETFs considered alternative investments?
Generally no. For the most part, exchange-traded funds (ETFs) are passive investments — meaning they track an index — and typically that index is for a conventional asset class like stocks or bonds. That said, some ETFs track niche parts of the market, including certain types of alternative strategies, including options, long-short strategies, managed futures, real estate investment trusts (REITs), and more.
Are alternative investments only for wealthy or accredited investors?
No. While some alternative assets are mainly available to accredited or high net-worth investors (e.g., hedge funds, private equity), many are accessible to retail investors who are willing to try new markets and new instruments (e.g., forex, derivatives) or access these strategies via mutual funds or ETFs.
Are cryptocurrencies considered alternative investments?
Yes, cryptocurrencies are typically less correlated with traditional assets like stocks and bonds. While crypto remains highly volatile, these digital currencies have become more widely available through vehicles such as ETFs.
How much of my portfolio should I allocate to alternatives?
Deciding how much of your portfolio to allocate to alts is largely dependent on your personal risk tolerance. Owing to the potential for steep losses, investors may want to allocate a small percentage, and carefully select the type of alternative asset that best suits their goals.
What is the most common type of alternative investment for retail investors?
Real estate, particularly dividend-paying REITs, are among the most common types of alts for retail investors. This asset class is well established, and while all property can be subject to risks, real estate investments offer the potential for longer-term growth that may provide diversification. And REITs, which are required to pay dividends, offer the potential for passive income.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.
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.
Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.
Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.
Mutual Funds (MFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
CRYPTOCURRENCY AND OTHER DIGITAL ASSETS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
Cryptocurrency and other digital assets are highly speculative, involve significant risk, and may result in the complete loss of value. Cryptocurrency and other digital assets are not deposits, are not insured by the FDIC or SIPC, are not bank guaranteed, and may lose value.
All cryptocurrency transactions, once submitted to the blockchain, are final and irreversible. SoFi is not responsible for any failure or delay in processing a transaction resulting from factors beyond its reasonable control, including blockchain network congestion, protocol or network operations, or incorrect address information. Availability of specific digital assets, features, and services is subject to change and may be limited by applicable law and regulation.
SoFi Crypto products and services are offered by SoFi Bank, N.A., a national bank regulated by the Office of the Comptroller of the Currency. SoFi Bank does not provide investment, tax, or legal advice. Please refer to the SoFi Crypto account agreement for additional terms and conditions.
A short ladder attack is a supposed trading condition in which hedge fund sellers come together to drive down a stock price that is already undergoing bearish pressure. Retail investors are often seen as the victims in this situation.
While not a purely defined strategy, some individual investors believe that these efforts work to the detriment of smaller traders. The theory is that as an asset’s price moves lower it prompts other investors to dump shares, leading to prices spiraling even lower.
Key Points
• Short ladder attacks are thought to involve coordinated efforts to drive down stock prices.
• Distinguishing these attacks from normal market activities can be difficult.
• High trading volume on downward price moves suggests potential short ladder attacks.
• Short ladder attacks are believed by some to be an attempt to manipulate the market.
• Retail investors often feel victimized, particularly on platforms like WallStreetBets.
How Does a Short Ladder Attack Work?
The short ladder attack strategy became notorious during the meme stock craze of early 2021 when shares of companies like GameStop (GME) and AMC Entertainment (AMC) experienced intense volatility and massive short squeezes. It was alleged that large investors responded with short ladder attacks to drive prices back down.
The theory behind a short ladder attack begins when an institution builds a large short position in a security. Shorting, effectively, means that you’re betting against a security’s appreciation. So, theoretically, if an asset’s value falls, the short seller profits.
With that in mind, a short ladder attack may appear to involve a form of market manipulation. Traders buy up shares, then sell them off over a period of time to create the appearance of changing demand for the asset, artificially altering its price.
A short ladder attack is meant to give the impression that shares of a stock (or any asset) are not worth what bullish investors believe, thus inducing other traders to dump shares or simply discourage others from buying.
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Are Short Ladder Attacks Legal?
Whether or not a short ladder attack exists and is breaching market manipulation laws is ultimately up to regulators to decide. It is important to recognize that short selling volatile assets is an age-old Wall Street practice. In fact, according to the U.S. Securities and Exchange Commission (SEC), short sellers add liquidity to the market. More liquidity can reduce trading costs for other market participants.
During bear markets, however, short sellers have sometimes come under scrutiny from both regulators and the investing public for their perceived efforts to bring down key stocks and the broader market.
In extraordinary situations, shorting stocks is sometimes ruled illegal — at least temporarily. Regulators will occasionally ban selling groups of assets short with the goal of stabilizing financial markets during periods of turmoil, such as during the Great Depression and the financial crisis of 2008-09. Beyond those instances, short selling is not illegal.
Short ladder attacks are infamous in the sense that traders engaging in such a strategy seek to drive asset prices lower. At times, there may be an illegal attempt to take a stock price down.
Where is the line drawn? It’s when a trader manipulates the laws using malicious activities like lying about a company, bribing others to not buy shares of the targeted firm, or the practice of spoofing.
Example of a Short Ladder Attack
Short ladder attacks are not something traders see every day. In fact, they can be hard to spot. It’s not a truly defined term, rather it is a loose theory.
Still, market analysts and traders can suspect a certain stock is under this “attack.” Potential examples include popular WallStreetBets meme stocks from early- to mid-2021: GameStop (GME), AMC Entertainment (AMC), and Bed Bath & Beyond (BBBY).
When shares of those companies began to falter during the first quarter of 2021, after their meteoric rise in the preceding weeks, conspiracies began to arise within internet chat rooms. Retail investors, who had lost money by being long those shares, claimed they were victims of unscrupulous trading strategies employed by large funds by way of short ladder attacks. It was thought that hedge funds came together to enter low bids that drove those securities lower.
Ask a short seller, and they might tell you that this strategy does not exist. After all, conspiracies to drive down a share price could venture into the market manipulation area, which would be against financial market rules.
💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.
How Can You Identify a Short Ladder Attack?
Even as big-time traders dismiss the practice, short ladder attacks are thought by some retail traders to be a normal practice. Spotting these maneuvers is no easy task since selling pressure can come from a host of market participants for a variety of reasons.
Perhaps there is bad news about a company that might fundamentally bring about the bears (who have no ill intent). Maybe a stock drops below a key technical level, leading to further selling. Moreover, it could be that major company insiders are dumping shares simply to raise cash for personal reasons. All these scenarios can give the impression of a short ladder attack.
You still might wonder, “what is a short ladder attack?” in real life. Some possible hallmarks could be high volume on downward price moves. Also, be on the lookout for brief squeezes in which short sellers are forced to engage in covering — when bears quickly buy back stock they are short to avoid steep losses. Also, stocks with high short interest could be targets of a short ladder attack. Basically, whenever floods of offers hit a stock for no apparent reason, that could be viewed as a short ladder attack signature.
You might recall the mother of all short squeezes (colloquially named MOASS) term. It’s when a flood of buyers bid up shares that were being shorted by other investors. GameStop’s example was one to behold in that the price jumped hundreds of percent over the course of a few days.
Short Ladder Attacks and WallStreetBets
According to those on WallStreetBets, short ladder attacks exist to work against individual investors. By flooding the market with offers, the supply/demand balance tips greatly in favor of the bears. Posts on WallStreetBets attempted to call out the practice, but little (if any) regulatory action has been taken.
This abusive ploy is alleged to be executed by a consortium of hedge funds, prime brokers, and even potentially regulators and clearinghouses. Target stocks are determined and prioritized, almost like a hit list. After driving shares lower, the short sellers avoid capital gains tax since they never have to cover their shares.
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The Takeaway
Short ladder attacks are alleged bearish trading activities performed by large institutional traders that can work against retail traders who are long a stock. Shorting stocks is not illegal, and can indeed help add liquidity to the market. If it’s determined that widespread shorting is crossing the line into market manipulation, however, it could potentially lead to legal issues. Many large hedge fund managers claim to be unaware of such a practice.
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FAQ
What is a short ladder attack?
Short ladder attacks are alleged bearish trading activities performed by large institutional traders that work against retail traders who are long a stock.
Are short ladder attacks legal?
Short ladder attacks are an alleged activity that may face regulatory action if it’s determined that an attempt to manipulate the market is in play, which is not legal. While short ladder attacks are a familiar concept, it may be difficult to determine if shorting activity is an attempt to manipulate prices.
Is it possible to identify a short ladder attack?
Yes, if you know what to look for. Some possible hallmarks could be high volume on downward price moves. Also, be on the lookout for brief squeezes in which short sellers are forced to engage in covering. Also, stocks with high short interest could be targets of a short ladder attack.
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