Many think it is only possible to profit in the stock market if you are invested in a rising market, although this is the most common way to profit in the stock market it is not the only way. There are ways in which you can actually profit from a recession and stock market downturn. Follow along because there is more than one alternative.
Can you really buy something you don’t own?
As crazy as it sounds yes you can sell something you don’t own and in fact it actually happens millions of times daily the concept is called shorting. The best way to understand how shorting works is to simply reverse the process of how you would normally buy a stock. You can practice how to do that here. When we purchase a share we buy it first then sell it after closing the position, when we short something we sell it first and then buy it back after closing the position. What is effectively happening is you are borrowing shares then selling them at the market price immediately then hoping to buy the stock back cheaper closing the position and making a profit . Therefore you would only short an asset if you think it will fall in value.
What are the risks of shorting?
There are many risks when shorting the first big one is that when traders short an asset they have unlimited risk. This is because the asset could rise to an infinite price which means to cover your short position you may need to pay more than you first shorted with. When you buy an asset long you can only lose the total amount you invested.
Shorting has trading risks as well one being that when a stock is on the rise and multiple investors are closing their short positions through buying back shares. It creates increased buying pressure on the stock causing it to rise more which in turn leads more short investors to cover their shorts though buying more shares. This is known as a short squeeze and can occur anytime.
An additional risk is if the stock’s price falls to 0 even if you were successful in shorting the stock and it went down as you predicted if the stock goes to 0 your short position is worthless. This is because if there is no market left to buy it back in then you would be unable to close your position which means you would lose your total investment.
Why shorting using CFDs can be less risky!
When trading with CFDs there is less risk is because there is no possible way you can get an unlimited loss with your short position. We believe this is the biggest risk of shorting overall. The reason this is possible is because certain companies that allow you to trade CFDs have a stop loss feature automatically build into their program which prevents investors losses exceeding their initial investment. CFDs are offered on trading platforms such as etoro and plus 500 they allow you to short sell very conveniently at the click of a button. This is hugely convenient as investors no longer need to go through a long traditional process like talking to a broker and borrowing shares to short.
Alternative ways to profit from a falling market
One sure way to protect yourself from a falling market is a black swan fund these are funds that prepare for the worst and if you invest in these funds during a market downturn you would profit significantly for example due to the recent COVID 19 black swan event. Some Black Swan funds gained over 4000% due to COVID 19 these funds are designed in a way that uses derivatives and other financial tools like shorting to benefit from a falling market. As these events are so unpredictable it may be wise to allocate a small portion of your investment portfolio to a black swan fund using diversification to hedge your portfolio just in case the unthinkable happens like COVID 19. Even with a small portion allocated you would be able to protect your downside risk as these funds see significant returns when the economy freefalls.
Although shorting in the past has been extremely inaccessible to retail investors in the past it has become a lot more accessible. This is due to company’s such as etoro, plus 500 and XM they make it very simple and easy to short there is no need to go through a complex process to short. On these CFD platforms, all you need to do is simply click a button. Now that short is accessible to almost everyone there is absolutely no reason why you too cant benefit from a falling market.