Trading and Investing Terms and Jargon: What are Headwinds and Tailwinds?
Definition: What are headwinds?
A ‘headwind’ is a financial term used to describe a macroeconomic factor that will likely negatively impact a market - an external factor that could cause it to be less profitable or grow slower through no fault of the market’s own intrinsic worth.
The word ‘headwind’ is actually a nautical term that comes from sailing, but is sometimes used in aviation as well. It describes weather conditions that mean strong blasts of wind buffeting your boat or plane ‘head on’, making forward progress difficult or impossible. Financial ‘headwinds’ affect markets and economies the same way.
An example of a headwind in finance could be something like a global recession, or tighter monetary policy from central banks. These would affect multiple markets worldwide, despite being completely external to and independent of their own internal environments. In fact, headwinds are often associated with bear markets or herald the start of a downturn, because of their negative impact on economic growth.
What are ‘tailwinds’ then?
Tailwinds is another term you may hear, apart from ‘headwinds’. There are also external factors, macroeconomic events and circumstances that put a lot of positive momentum behind a market, making strong growth and profitability easy for many.
Picture a market you’re trading on as a boat - a ‘tailwind’ would be a welcome wind coming from directly behind the vehicle, pushing it forwards with little to no effort on your part.
In the stock market, an example of a ‘tailwind’ would be strong GDP figures and a bullish, expanding economy. We explained that high interest rates would be a headwind for most markets, but for banks they may actually be a tailwind, for example - boosting banking profits as interest is now worth more, which in turn ups banks’ net interest margins.
Where you may hear about headwinds - and why
As a trader, you’ll hear about ‘headwinds’ or ‘tailwinds’ in economic reports by market analysts, economists and other financial experts when they dissect the overall, macro state of an economy or industry. That’s because headwinds (like a low-growth, pessimistic environment) or strong tailwinds (like the bullish, high-growth environment of a booming economy) affect everyone, not just one asset class.
Stocks can also be affected by both headwinds and external tailwinds, and you may hear these terms in a quarterly earnings report when individual companies release their latest results come reporting season.
What should you do as a trader when headwinds arise?
As a general rule, talk of headwinds means that there are challenging times ahead, in which it may be very difficult for investors to find profit and avoid loss. However, for traders who can short underlying assets as well as go long, headwinds may be an opportunity - if they can keep their head in tough economic climates and have a thoroughly tested strategy in place.
Every trader’s goals, strategy and style of trading is unique, and that means each will respond to macroeconomic headwinds in different ways. That being said, most traders find it prudent to shift more emphasis on preserving capital and risk management when the strong winds blow, rather than a simple mindset of ‘make as much profit as possible’.
This can mean hedging positions more (as headwinds arriving sometimes accompany uncertainty in the market in the short-term) and more diligent risk management such as being conservative with position sizes and your leverage ratio.
It can also mean diversification into speculating on other underlying assets than ‘your usual’. Because headwinds are often associated with bear markets, many traders will shift focus onto underlying markets that are ‘safe havens’ known to hold onto their value during tough times, such as the spot gold price, and pivot away from assets that are traditionally associated with bull markets times such as equities.
Regardless of what the economy’s doing, successful traders will always find a good risk management strategy important. Stop losses and take profit orders, for instance, on every position and thorough research before jumping into any new market.
Conclusion: Why is it important to know terms like ‘headwinds’?
Just like any industry, finance has its own special terms and jargon words, and knowing these is key to trading with confidence and understanding the information put out by finance experts, which can be full of insight and opportunity for traders.
Knowing what these industry insiders mean when they speak of ‘headwinds’ and ‘tailwinds’ also empowers you to adjust your trading strategy accordingly and sail out of a headwind with as little loss (or even as much profit) as possible.
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