Active Traders Academy Blog

Over the past ten years since I’ve been playing the stock market, I always get asked by people what is the quickest way to make money in the stock market. Is it by finding a good company stock and buying low and then selling high? Or maybe it is finding some good news about a specific company and buying before the stock price goes higher? How bout finding a company stock or sector that is performing very poorly but it hasn’t been reflected in the stock price? What I am referring to is betting the stock price will go down and profiting from it. You might ask yourself, how is that possible? Most people believe they can only make money when the stock market goes up but I am going to introduce you a concept called short selling.

Short selling is a key component of most hedge fund managers and involves the borrowing and selling of a stock that the investor doesn’t own in anticipation of buying it back at a lower price in the future. Therefore, investors attempt to profit from a decline in a company’s stock price. Collectively, a short stock portfolio can profit from a stock market decline and thereby act as a portfolio hedge to long positions that would likely decline during a stock market correction. As well, investors can short company stocks and profit from their decline based on poor company fundamentals. These factors can include poor management, overvaluation and declining revenues. During the financial crisis in late 2008 and early 2009, many investors saw their stock market portfolio decline rapidly. In fact, so many people lost money in the stock market that they never invested in the stock market again. However, there were other investors who generated huge returns during this period of time.

How did they do it? They invested in inverse ETF’s or commonly called Exchange Traded Funds. These ETF’s offered investors the ability to profit or profit themselves during a downward trend in the stock market. Inverse ETF’s go up in value as the stock market or sector goes down. A good example is in late 2008 when the US Real Estate sector was performing poorly, one of the popular Inverse Real Estate ETF’s (SRS) went up 500% in 3 months. In fact, most of the inverse ETF’s went up in value during the financial crisis time period. Besides the usual benefit of an etf like ease of use, there are two other reasons inverse etf’s can fit well in an investor’s portfolio. If an investor has an account that doesn’t allow shorting stocks, the investor can buy an inverse etf instead. Another reason is that an investor will not have to hold a margin account as he would when shorting a stock. This means that the investor doesn’t have any margin risk which could cause the investor to lose more than he owns.

Another example of short selling becoming more prominent in the world stock market is in China. Since the Shanghai Stock Exchange was founded in 1990, Chinese investors have only been able to bet on prices going in one direction and it is up. That is set to change, however, as the government in Beijing has approved long awaited reforms that will allow traders to profit from falling, as well as rising, markets.

What is the biggest risk to short selling? History has shown that, in general stocks have an upward bias to the upside. Over the long run, most stocks appreciate in price. So if the direction of the stock market trend is up then a short position can be quite risky. Short selling is mainly for investors who want to profit on a specific company or sector that is performing poorly in the short term. This could range from 3 to 6 months.

What are some inverse etf’s to buy? Here are a few to consider when the stock market is dropping: DOG (Dow Jones 30 index), SH (S&P 500 index), PSQ (Nasdaq 100) and SEF (US Financial Index).

The stock market has had an amazing performance since March 2009 and recently in the past week, it has fallen sharply. Maybe it’s time to take a look at protecting your stock market portfolio and profiting from the declines in the stock market.