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What Is an Inflation Trade?

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  • Written By: Mary McMahon
  • Edited By: Shereen Skola
  • Last Modified Date: 19 September 2014
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An inflation trade aims to take advantage of a projected rise in prices caused by inflation. This tactic involves identifying financial products that might be subject to inflation and selectively buying them in order to secure a good position in the future market. It differs from acknowledging that inflation may occur and planning for the eventuality with trading moves to reduce risk and hedge investments. Some traders view this type of trading negatively, while others find the inflation trade a perfectly viable and reasonable investment tool.

A number of factors can contribute to inflation, determining how much prices rise over time and how quickly that change occurs. Financial projections can help traders and others prepare for inflation by making estimates that may guide investment decisions. People don’t want to buy securities that will not have good returns during periods of inflation and they want to pick those that are likely to generate the most profit. Inflation can cause spikes in gold prices, for example, making gold and gold-related securities a good buy before a period of projected price increases.

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Traders can take advantage of public analysis from government agencies and financial magazines as well as private research to determine when inflation is likely to occur and which patterns it may follow. This research helps them decide how to place an inflation trade. Careful market movements may be necessary to avoid spooking other investors and potentially creating a panic that might lead to a rapid escalation in price, followed by a crash as the market recovers. Large investors like financial institutions are especially careful with trading tactics, for this reason.

There are no specific bans on inflation trading; there is nothing to stop a trader from making a trade intended to take advantage of anticipated inflation. An inflation trade can be a sound strategic move for traders who make accurate market predictions and are willing to be patient with market observations. Opponents may argue that the practice can increase the risk of inflation on individual commodities.

This tactic requires good prediction abilities. If a trader bets incorrectly, inflation could cause the value of an investment to shift negatively, leaving the trader holding a bad market position. Rapid and high inflation can also cause more volatility, which may make it more difficult to take a safe position in the market and hold it. These are risks traders may consider before moving ahead with an inflation trade, whether for themselves or on behalf of a client or employer.

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