Every day, the stock market seems to continue its precipitous drop towards worthlessness, crushing hopes, dreams, and investors in a flurry of dizzying price movements. Yet there is an answer; a light in the darkness, used by the masters of investment to generate excess returns even " no, scratch that, - especially in falling markets like this one.
The technique Im referring to happens to be popular with hedge fund managers " those stock market whizzes pulling millions of dollars a year in exchange for managing their portfolios. This technique was also responsible for the creation of many a millionaire during the 1929 stock market crash. Yet this same technique is shunned by the public, due to its intrinsic counter-intuitive nature. Still, mastery of this technique " and its a lot simpler then you may think " its essential to doing well in bear markets such as this one.
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 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.
Another way to think of shorting stocks is to own a negative number of shares... If you own 100 shares of a stock, and it goes down $10, then you lost $1000. If you own -100 shares of a stock (or your short 10 shares of a stock), and it goes down 10$ then you gain $1000. Of course, if the unthinkable happens, and the stock appreciates by 10$, then your down $1000 (What, did you think it was riskless?).
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. - 16732
The technique Im referring to happens to be popular with hedge fund managers " those stock market whizzes pulling millions of dollars a year in exchange for managing their portfolios. This technique was also responsible for the creation of many a millionaire during the 1929 stock market crash. Yet this same technique is shunned by the public, due to its intrinsic counter-intuitive nature. Still, mastery of this technique " and its a lot simpler then you may think " its essential to doing well in bear markets such as this one.
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 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.
Another way to think of shorting stocks is to own a negative number of shares... If you own 100 shares of a stock, and it goes down $10, then you lost $1000. If you own -100 shares of a stock (or your short 10 shares of a stock), and it goes down 10$ then you gain $1000. Of course, if the unthinkable happens, and the stock appreciates by 10$, then your down $1000 (What, did you think it was riskless?).
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. - 16732
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Confused about ETF's shorting stocks, crashing markets or any of the other terms? Or just interested in cashing in on this huge opportunity? Click here and Learn How to short stocks and make money
