Learn how trading flat works, what it means for your portfolio, and what to do when it occurs.
Definition and Example of Trading Flat
The term trading flat can slightly vary in meaning, depending on which context it is used in. If someone is using the term in relation to a market or exchange, then trading flat refers to the fact that the exchange index has been unchanged for a certain amount of time. When it comes to stocks, trading flat means that the stock price has neither fallen nor risen during the period being reviewed. When it comes to bonds or other forms of fixed income, it simply indicates those investment products are trading without accruing any interest. If a bond trades flat, the buyer won’t be responsible for paying the seller any interest that has accumulated since the last coupon payment. All that being said, the overarching meaning of this term is that the price of a security is neither increasing nor decreasing; it’s remaining relatively the same.
Alternate name: trade flat
How Does Trading Flat Work?
A flat market leads to securities trading flat. When a market is flat, that means that there isn’t much price movement and that the market is trading within a tight range. There will be little indication of whether the market is trending up or down. A flat market can occur for a variety of reasons. In some cases, investors simply may be losing interest in the specific investment vehicle that is trading flat. Important financial events, or lack thereof, can also cause securities to trade flat. For example, let’s say that on an upcoming Thursday, there is a planned economic indicator release that is expected to cause volatility. Some traders may be too hesitant to add exposure without knowing which way the market will turn and therefore may choose to pull back on trading activity for hours or even days leading up to the economic event. This is one potential reason behind a market trading flat. To better understand what trading flat means, it helps to understand what market volatility is and what it reflects. The price of options is greatly affected by market volatility. Volatility measures how much the value of an asset or its price will change during a select time frame. If a market experiences prices remaining stagnant for a long period of time, that’s a low-volatility market. If the price moves up and down frequently, especially in large volume, that market is a volatile one. When the market is highly volatile, you’ll typically see that an option’s value is higher. Markets with low volatility are often associated with lower option values. Low-volatility markets are more similar to flat markets. Let’s take a closer look at what happens when a bond is trading flat. When someone purchases a bond at a discount because interest has accrued but has not been paid or has been defaulted upon, this process is referred to as trading a bond flat. It’s generally due to some type of financial distress. Because that unpaid or defaulted interest is not considered income, it is not eligible for taxation as interest later on, if paid. This means that if the investor receives a payment of that interest, it’s a return of capital. Because it is considered a return of capital, the remaining cost basis of the bond is reduced. Any interest that accrues after the date of purchase is considered taxable income for the year the investor accrued it or received it.
