What Can You Do When The Stock Market Starts To Look Overvalued?

in Market

The major stock markets around the world have a habit of overreacting in both a bull market and a bear market. This is great in a bear market because you can pick up some real bargains, but it's not so great in a bull market (unless you're fully invested already). However you can still make money from the markets even when the markets have raced to new highs and are starting to look overvalued. 

One option is to start looking for short positions. This is not something I particularly like to do myself because sometimes the markets will just keep on going upwards, supported by positive investor sentiment. 

However you can still make money in some instances. The trick is to scour the markets looking for under-performing companies. Ideally these companies should be in a weak sector and have high and unsustainable debts. Furthermore they should either have flat or falling profits in the next few years according to analyst forecasts. The best companies for shorting are often the small and medium-sized companies because the share price of these companies is not driven or influenced greatly by the main index, so will move independently of the major indices. 

If you don't want to open any short positions, you can simply focus your attention on finding undervalued companies amongst some of the smaller listed companies. The fact is that even if the wider stock market has rallied strongly in recent months, there will always be bargains to be had amongst the smaller companies because they often fly under the radar, and as I've already mentioned, the share price of these smaller stocks move independently of the wider market. 

One final option you have is to focus your attention of generating an income with your spare capital. So even though there may be little opportunity to make any real capital gains when the market is overbought, you can look for high yielding dividend stocks, possibly amongst the smaller stocks to protect yourself from any share price falls should the market turn, or you could invest in bonds, for example. 

The point I want to make is that you can still put your money to good use even when the market is overvalued. You can either start building short positions, ideally on some of the weaker stocks, you can start investing in some of the smaller stocks that are unaffected by the wider market, or you can look for income-yielding investments. You don't always have to invest in the large well-known stocks that are heavily influenced by the movements of the major stock market indices. There are lots of other options available to you.

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James Woolley has 19324 articles online and 24 fans

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What Can You Do When The Stock Market Starts To Look Overvalued?

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This article was published on 2010/09/15