5 Rules to Trade a Sideways Market

The latest sideways market gyration, primarily driven by the uncertainty over Europe’s still-unresolved bailout deal, has many traders scrambling to try and navigate this sideways market. Certainly, the volatility we’ve seen in stocks over the past two months — a September decline of about 7% on the S&P 500, a near-11% surge in October and a November that started with a boom and now is down 3% — has a lot of investors scrambling to get on the right side of the trade. The recent volatility has prompted numerous market pundits, mutual fund managers and stockbrokers to come out and claim that trying to trade the market is a losing game, and that what’s best for investors is to just buy and hold stocks for the best results.

Unfortunately, the facts just don’t support that thesis.

If we widen the angle on our market lens and look at what’s happened over decades in stocks, we see that a buy-and-hold strategy has delivered anything but stellar gains during huge chunks of time. In the chart below of the Dow Jones Industrial Average since 1928, we can see how roughly the past 10 years in the market has essentially provided investors with negative returns. The chart also shows that the last 10 years has been anything but an anomaly.

Click to EnlargeFrom the mid-1960s to the early 1980s, there was a period of 17 years where a buy-and-hold investment in the Dow would have netted you a -1% return. If we go back even longer, we see a 25-year period from late 1928 to late 1953 with a total return of -1.5%. So you see, the notion that buying and holding stocks in a broader sideways market is the way to go just does not comport with reality.

So, what is an investor to do? How do you make money in stocks when stocks are basically going nowhere? The only viable solution is to do exactly what the buy-and-hold advocates don’t want you to do — and that is to be more active with your investment capital by trading stocks.

Of course, not all trading strategies are created equal. Day trading in and out of positions is almost never suitable for the individual investor trying to increase his/her total wealth. However, making sure your money isn’t exposed to a big downturn — such as the selloff that took place from late July through early October — is critical if you want to preserve and grow your investment capital.

While trading stocks can take many forms, there are some basic guidelines that apply to any trading plan if you want to maximize your chances of trading success.

Here’s a short list of five rules to follow that will help your trading plan succeed: