Flight to quality is when traders pull money out of risky markets or investments to invest in places with less risk. This often occurs when stocks take bearish course, causing investors to have negative sentiment about securities in the market. Following is some information on what flight to quality in investing is, and what can result from it.
What is Flight to Quality in Investing?
Flight to quality is when traders leave, or fly away from, risky investments, and move money to safer, quality places. This can describe any trader’s pulling out money to avoid potential risk, but often, high volumes of investors act at the same time to get out of risky situations.
For example, if a stock begins a downtrend, even if the trend is caused by bearish sentiment and panic selling, which could result from anything, high volumes of traders may pull out of it, perhaps resulting in capitulation, which causes its price to plummet, because investors are afraid of the loss that could be realized in holding onto the security. If these traders pulled out to invest in stock that was not as likely to fall as much, even if the new investments had much smaller potential gains, a flight to quality situation would arise.
Flight to quality in investing can also describe traders that completely relocate funds. Moving money from the markets of one nation to another, or pulling out of volatile stock and investing in stable commodities or bonds is flight to quality. Government investments are also commonly invested in when traders are afraid of risk.
What Happens with Flight to Quality
Essentially, when this investing phenomenon occurs, traders will exchange lower potential returns for safety, resulting from their fear of loss. This can cause the risky investments that they leave to experience sharp loss.
Oversold stock often results from flight to quality. When investors start pulling out of investments that have a lot of potential risk and also have great potential returns, the risk starts to be realized, and the price of the stock from which the investors “fly” is driven down. When this happens with a number of stocks, a bear market, where falling stock prices are supported by investors that pull out of falling or risky stock can result.
This will often culminate in very low prices for a number of securities, some of which may turn around and rally as investors again buy into them, and others of which can take the other route, and shares can be worthless as companies go bankrupt.
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