How to Stay Sharp in a Dull Market

With stocks in their least volatile period seasonally (June to August), now is the perfect time to gear your portfolio up for the second half of the year — when things really get moving.

Here are three strategic moves you can make today…
1) Fatten up Your Watch List

Louis Pasteur famously once said, “Chance favors the prepared mind.”

I couldn’t agree more.

The better prepared you are for what the market hands you, your chances of bagging big gains on stocks increase.

As such, an investor should always have a list of well-researched stocks ready to go when an opportunity presents itself.

This goes for long-term buy-and-hold investors and short-term traders alike.

For me, a good stock list has five to ten stocks from different market sectors. I also note the price I’m willing to pay for them and determine a near-term price target (usually one year).

Now, long-term investors don’t really need a price target. But if you’re planning on holding a stock for less than two years, having an upside target can help you to build an appropriate reward-to-risk ratio.

This ratio is simply a trade’s net profit divided by total exposure.

At a minimum, most traders are looking for a 2:1 return on capital. The most aggressive traders are often trading setups of 4:1 or more.

For a price target, you could easily use Wall Street’s consensus one-year price target (which can be found on sites like Yahoo or Google Finance). You could also craft one using your own valuation model, or use an online calculator.

Any way you slice it, armed with a watch list ahead of time, you’ll know exactly what to buy — and when it’s time to pull the trigger.
2) Mind Your Stop Losses

The second most important thing to do in a calm period is to adjust your stop losses.

After all, the best way to make money is not to lose it in the first place.

Most buy-and-hold investors use trailing stops, which automatically trail a stock by a percentage (like 25% or 35%).

And generally speaking, you shouldn’t need to adjust them unless a stock becomes more volatile than usual.

But if you’re sitting on a sizeable profit and you’ve got a hard stop (which is a manually set limit price) on a stock, you might consider raising your stop to lock in your gains.

This is especially true during long periods of low volatility, as they tend to be followed by large moves in stocks.

Louis Basenese uses strict stop losses at our flagship publication, True Alpha. To learn more about this research service — along with a list of new currencies now available to trade — click here.
3) Consider Options to Increase Alpha

Options are one of the best tools available to investors to pull outsized gains out of the market, yet they are widely misunderstood — and, as a result, misused.

When used correctly, however, they don’t only magnify gains over regular stock returns but actually are safer instruments than stocks.

As you may know, volatility is one of the biggest factors in the pricing of options. And when volatility is low, options get cheaper.

So let’s say you’re sitting on a stock that’s doubled in price over the last five years. Furthermore, you think shares have a bit more room to run but you want to take some profit off the table.

Consider selling your shares and using some of the proceeds to purchase a deep-in-the-money call option.

This strategy is called stock replacement, and it allows you capture a stock’s upside at a fraction of the cost to owning shares.

Bottom line: Don’t let this dull market lull you into sleeping on stocks. Let your winners ride and use the time — and these strategies — to prepare yourself for when stocks really start moving again.