If you’ve passed Investing 101, you understand the principal of buying low and selling high. When markets start low and trend up, you want to buy until the price becomes too rich, when you sell.
If you’re content with passive, long-term investing, there’s little you need to do. On a long enough horizon, the stock market appreciates and yields a modest but predictable average annual return.
If you want to be a more aggressive investor, however, you may get into making more frequent trades to take advantage of the market’s natural cycles.
This is easier to do when the markets surge or plunge, but much of the time the stock market isn’t on an obvious rally or crash. This is called a horizontal, flat or sideways market, and it’s defined as a period in which prices waver within a narrow range without a clear upward or downward trend.
Such a barren landscape can lull you into apathy and leave your money sitting high and dry. Flat markets don’t have to be a time of financial drought for your portfolio; there are several strategies that can help you turn a profit.
Dividend stocks yield steady returns
The most common and best way for most investors to play a neutral market is to invest in stocks that pay dividends. Even if a stock trades flat, the dividend yield still produces profit.
Many dividend-paying stocks also have active stock buyback programs which will help prop up falling prices by repurchasing shares and providing you with another line of defense.
One of the anomalous features of a neutral market is that it necessitates stock picking. Not all dividend paying stocks are created equal. Payout ratios, earnings-per-share, and consistency are key fundamentals when researching these kinds of stocks. A high payout ratio can be an indicator that there are few growth opportunities for the company and likely cannot sustain its dividend for the long term.
In shaky markets, stocks that have a steady history of paying dividends and reporting solid earnings are telling you that they have weathered storms before and still produce positive results.
Read more about dividend stocks (TheStreet.com).
Options as hedges
Using options are another way to generate income. Options are an advanced strategy that, to the novice, pose more risk than buy-and-hold investing, but used smartly options can help you manage risk and find profits in flat markets.
There are at least two big ways to use options in a flat market: covered calls and bull spreads.
Covered calls are considered the most conservative investing strategy using options. If you own a stock that you think is going to trade sideways for a while but still want to generate some kind of a return, you can sell a call at a higher price than it currently trades at and collect the premium. It also protects on the downside by lowering your cost basis. If the stock does climb more than you expected, you still keep the premium and profit from the spread between the stock’s current price and the price you sold the call at.
Bull spreads allow you to benefit from a potential stock gain without actually fronting the dollar amount needed. By buying a call with a lower strike price and selling a call with a higher strike price, a profit range is locked in for less than the price of simply going long a call. This lets you play the stock market without putting a large amount of money at risk.
Read more about options trading strategies (The Options Guide).
Small caps buck the trend
Some investors prefer to take risks whenever possible, making a profitable strategy difficult to find in markets trading sideways. Like weeds thrusting up from the smallest crack in the driveway, small cap stocks find ways to grow. That’s because they usually perform based on a company’s underlying fundamentals, irrespective of the macroeconomic influence that burdens larger cap stocks.
These smaller companies tend to be overlooked by analysts allowing their stock price to more accurately reflect the true value of the company rather than being affected by the tides of the overall stock market. This creates opportunities for investors who are willing to do their homework and apply the principles of fundamental analysis.
Again, investing in small caps is a more advanced (and certainly risker) proposition than investing in blue chips. And if you do choose to go this route, do not equate buying fundamentally-sound small caps with gambling on penny stocks.
There are always opportunities if you can spot them
The stock market is a dynamic power that can play tricks on the unsuspecting investor. The placid surface may seem as still as a mountain lake, but strong currents can operate underneath in certain sectors. The trick is becoming smart enough to find them.
Stocks aren’t the only investment available to you, either. When stocks are doing poorly, other asset classes like bonds and commodities may not be experiencing the same problems and could be good areas to invest. There is always a bull or bear market taking place somewhere if you look hard enough.