Even yoda might have trouble figuring out the current market environment. In a world of falling prices, how can wealth be protected? I have some news for you. Even in a falling market, wealth can be not just preserved; it can be created. With just a few simple techniques, Ill show you how to supersize your portfolio.
Shorting stock. The phrase sends a blood-curdling chill down many a buy-and-hold investors spine, frightening them into a shock-induced state of confusion. Yet for masters of this easier-then-it-sounds technique, its an extremely profitable oasis within the uncompromising desert that is this bear. Confused? Its like this… the vast majority of investors only buy stocks. When you buy a stock, there are two ways to make money. Stock price appreciation (buy low, sell high), and dividends. Which is all well and good when the market is going up, but for markets such as the one were currently embroiled in, we need a whole different animal.
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.
Even still, shorting stocks has risks. If you choose the one stock of 100 that is about to start trending upwards, you could lose some money on that. Different sectors of the economy may also be effected by events that cause exceptions to the everything goes down in bear markets rule. The recent auto bailout could feasibly cause industrials to go up for a while, so shorting industrials could choose to be a bad choice. The biggest risk is that the bear market turns into a bull market while your not paying attention ” that could rack up losses on many positions at once.
When deciding how to manage risk, a good tool to use is the 5% rule. This rule states that you should use stop losses to never lose more then 5% of your overall investment portfolio on any individual trade. So if you have a $50000 portfolio, then you should risk no more then 5% of that ” $2500 ” on each trade. This doesnt mean you shouldnt invest more then $2500 in any one idea. It just means you shouldnt lose more then that if things go wrong. Heres an example. If you buy a stock for $30 per share, and you set a stop loss at $25, you can lose up to $5 per share on that stock. This means you can buy up to 500 shares without violating the 5% rule. However, if your stop loss was at $20, you could only buy up to 250 shares without violating the 5% rule. 5% is also a bit high for most traders. Unless you have a very long timespan, most of your trades should be closer to the 2-4% range, with 5% being the highest risk trades.
When it comes to stock picking, some people would call this a challenging market. And traditionally, we have been taught that buying low and selling high is the idea scenario, so looked at from that sense, perhaps it is a challenging market. Or is it? With everything covered already in this short document, you have already learned that a so called “challenging market” can be a bonanza for those who have learned how to short a stock or etf.
Confused about ETF’s shorting stocks, crashing markets or any of the other terms? Or just interested in cashing in on this once in a lifetime opportunity? Click here and Learn How to short stocks and make money