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The current market environment has left a sour taste in many an aspiring millionaires mouths. The vast loss of value that has occurred in capital markets has been of historic proportion, and seems to have struck without rhyme or reason. Yet with some sophistication, portfolios can be protected and even flourish during this era of falling stock market prices.
Masters of short term stock speculation have long known about an ill-understood trading technique shunned by the masses. This technique makes money as stock prices fall, rather then profiting as they rise. This technique is known as shorting stock. Unlike purchasing a stock, where you buy it, and then hope that it goes up in value, or that you can collect the dividends from the stock far into the future, shorting a stock is a simple technique the masters use when they believe the stock will go DOWN. A risky play under normal conditions, but in a market like this, where most everything is dropping like a rock, its much safer then buying stocks.
While counter-intuitive, shorting stock is less complicated then you might think. The goal when shorting stock is the same as when buying; your trying to buy low, and sell high. The only difference is that you do it in the other order. You sell stock today, and you buy it tomorrow (or some other time in the future), hopefully for less. By doing so, you make a profit equal to the difference between your buying and selling prices.
An example... In late August 2008, Ford was trading for around 4.50. If you decided to short 100 shares of ford at that point, then you would borrow 100 shares of Ford from your broker and sell them for a total of $450. In late October 2008, Ford was down to the 2.25 range. At that point, you could buy back the 100 shares you sold for $225, return the 100 shares to your broker, and all in all, you made $225. In essence, you sold high, then bought low. Its just like buying low, and selling high " it just operates in reverse. This would be a good time to re-read this paragraph, its that important.
A more abstract, but ultimately easier way to think of shorting is a way of owning a negative number of shares. If when you own 10 shares, and a stock goes down by $100 , you lose $1000. If you own negative 10 shares, and a stock goes down by $100, you gain $1000. Simple as that. Naturally, an increase in price works the same way " a price increase means owning a negative number of shares leads to a loss, but in a bear market, thats a rare thing.
Regardless of how you play the markets, an eye must be kept on the most important element of all " risk. While shorting helps to remove some of the systematic risk from your portfolio " a portfolio composed of both buying stocks, and short stocks, is less venerable to a market crash " it does carry its own unique risks. Especially in a bear market, it pays to watch the news on your shorts. Any good news that comes out may raise the stock price of those that your shorting, and if a stock isnt going down anymore, its not a good stock to be short. The bigger risk to your short positions is the end of a bear market. When the new bull market ends, many short positions will quickly swing towards unprofitability, and so you must be quick to close them.
One standard practice among investment professionals is the 5% rule. This rule is used when deciding how many shares of a company to buy/short, and is an invaluable tool when shorting stocks. Lets say you want to short a $15 stock, but your not sure how many shares to short. First take the amount of money in your portfolio, say, $10000. Then, take 5% of that. $500. That is the amount you can risk on this transaction. Next determine the most logical stop loss. Lets say you decide if the stock goes above $17.50, youll sell your shares using a stop loss. If you can lose 2.50 per share, and your willing to risk $500, then you would short 200 shares of the stock, maximum. Many risk adverse investors choose only 2 or 3%, but 5% serves as a good maximum for even most risk-tolerant investors.
The current trend in the market is down. This is the most important thing to keep in mind when deciding where youll invest your money at this point in time. When the stock market is in bear market mode, almost all stocks are moving downwards. When this happens, it doesnt make sense to buy-and-hold like the masses. A far more productive approach is to find out whats working and to use that method instead. In the context of a bear market, the easiest way to make money is to short stocks or etf's.
Masters of short term stock speculation have long known about an ill-understood trading technique shunned by the masses. This technique makes money as stock prices fall, rather then profiting as they rise. This technique is known as shorting stock. Unlike purchasing a stock, where you buy it, and then hope that it goes up in value, or that you can collect the dividends from the stock far into the future, shorting a stock is a simple technique the masters use when they believe the stock will go DOWN. A risky play under normal conditions, but in a market like this, where most everything is dropping like a rock, its much safer then buying stocks.
While counter-intuitive, shorting stock is less complicated then you might think. The goal when shorting stock is the same as when buying; your trying to buy low, and sell high. The only difference is that you do it in the other order. You sell stock today, and you buy it tomorrow (or some other time in the future), hopefully for less. By doing so, you make a profit equal to the difference between your buying and selling prices.
An example... In late August 2008, Ford was trading for around 4.50. If you decided to short 100 shares of ford at that point, then you would borrow 100 shares of Ford from your broker and sell them for a total of $450. In late October 2008, Ford was down to the 2.25 range. At that point, you could buy back the 100 shares you sold for $225, return the 100 shares to your broker, and all in all, you made $225. In essence, you sold high, then bought low. Its just like buying low, and selling high " it just operates in reverse. This would be a good time to re-read this paragraph, its that important.
A more abstract, but ultimately easier way to think of shorting is a way of owning a negative number of shares. If when you own 10 shares, and a stock goes down by $100 , you lose $1000. If you own negative 10 shares, and a stock goes down by $100, you gain $1000. Simple as that. Naturally, an increase in price works the same way " a price increase means owning a negative number of shares leads to a loss, but in a bear market, thats a rare thing.
Regardless of how you play the markets, an eye must be kept on the most important element of all " risk. While shorting helps to remove some of the systematic risk from your portfolio " a portfolio composed of both buying stocks, and short stocks, is less venerable to a market crash " it does carry its own unique risks. Especially in a bear market, it pays to watch the news on your shorts. Any good news that comes out may raise the stock price of those that your shorting, and if a stock isnt going down anymore, its not a good stock to be short. The bigger risk to your short positions is the end of a bear market. When the new bull market ends, many short positions will quickly swing towards unprofitability, and so you must be quick to close them.
One standard practice among investment professionals is the 5% rule. This rule is used when deciding how many shares of a company to buy/short, and is an invaluable tool when shorting stocks. Lets say you want to short a $15 stock, but your not sure how many shares to short. First take the amount of money in your portfolio, say, $10000. Then, take 5% of that. $500. That is the amount you can risk on this transaction. Next determine the most logical stop loss. Lets say you decide if the stock goes above $17.50, youll sell your shares using a stop loss. If you can lose 2.50 per share, and your willing to risk $500, then you would short 200 shares of the stock, maximum. Many risk adverse investors choose only 2 or 3%, but 5% serves as a good maximum for even most risk-tolerant investors.
The current trend in the market is down. This is the most important thing to keep in mind when deciding where youll invest your money at this point in time. When the stock market is in bear market mode, almost all stocks are moving downwards. When this happens, it doesnt make sense to buy-and-hold like the masses. A far more productive approach is to find out whats working and to use that method instead. In the context of a bear market, the easiest way to make money is to short stocks or etf's.
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