Who Wants To Invest Now?
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.
To short a stock is essentially to sell it, and then buy it at a later date. Counter-intuitive, no? In the shorting process, you borrow the stock from your broker, sell it on the open market, and when the price has fallen sufficiently, you buy it back again, and return it to your broker.
An example… In late September 2008, Bank of America was trading for around $35.00. Shorting the stock at that point in time wouldve been extremely lucrative, as by late November, it was trading for around 15.00$. Shorting even 100 shares of bank of America, you would have made 2000$ (100 shares * $20 price drop). The process is something like the following. 100 shares of the stock, in this case, bank of America are borrowed from your broker, and then sold. You pocket the $3500. 2 months later, you buy back the shares for $1500, and return them to your broker, keeping the $2000 difference between what you bought them for, and what you sold them for.
For those abstract thinkers, it may be easier to conceptualize shorting as simply buying a negative number of shares. When you own 500 shares of a company, and the companies stock price increases by $1.00, you make $500. When you own -500 shares of a company, and the companies stock price increases by $1.00, you lose $500. However, when you own -500 shares, and that company then plummets by 5$, now you stand to gain $2500. As they say, the bull goes up the stairs, but the bear goes out the window. Markets fall faster then they rise, so the time to make money is now!
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.
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.
In a bear market, there is just one, singularly important, yet amazingly simple truth that must always be kept in mind. Everythings going down. Throw 3 random letters together, and pull up a stock chart, and every time, youll see declining prices throughout a bear market. With this in mind, shorting is the only thing that makes sense. Masters of this technique have been pulling millions in from the market since the dawn of the last century. As far back as the 1929 crash, Jesse Livermore made $100 MILLION using this technique. In a strong bear market, shorting etfs and stocks can be a brutally efficient cash machine.
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
