The standard investor strategy is to sell stocks on the rise, making a profit. Not all traders make money when assets are falling. Today, we’re talking about playing on the decline in prices. It allows you to increase your capital.
Is it “bear time”?
Seasoned financial players say, “Anything that goes up, goes down. Playing the Bear market is relevant in the current market correction associated with the COVID-19 pandemic.
Bear markets declines of over 20% were seen in 2008 and 2020. The drawdowns were 56.8 and 33.9%. Since 1950, the situation has recurred on average once every 7.78 years. After 1.84 years, there are corrections. And these are 10-20% declines. From 2008 to 2020 there were 6 declines and 7 drawdowns of 5-10%.
The exchange has a wide range of assets for trading. Profits are possible when the stock market is booming. As well as when the markets are falling. Assets are down or up at a stipulated price. Therefore, profits are generated in both situations if based on clear instructions.
A bearish (short) position is designed to lower prices. Investors should proceed with caution. Risk is minimized with a clear financial plan and experience. Interesting investment products help to work effectively.
How to Trade Down
You can wait for a rise and continue trading. But how do you take advantage of a downturn? An interesting option is to sell first, buy later.
It is important to make transactions within the trading session. It makes no sense to buy and sell in the medium, long term. Over the long term, the company runs the risk of going bankrupt. The investor will incur losses, left with a depreciated stock.
Short selling stocks
An easy way to make a profit on a low quote is to short sell a stock. It is not possible to sell non-existent assets on the stock exchange. You can borrow a stock from a third party, register with a broker to borrow it to open a short position. The rate will fall. And then you can buy back the cheap securities and return them to the owner.
Case in point. Nikolai believes that the company’s stock is going to fall. He does not have the securities and is going to borrow them. He borrows them from Anna, and pays him interest for the service. Having taken the shares, Nikolai sells them on the market, expecting the quotation to fall. Later he redeems them at a lower price, if he has planned everything correctly. The benefit is the difference between the sale price, the cost of re-purchasing, and the interest on the rent. Then Nikolai returns the papers to Anna.
If the rate falls, it is better to get a loan to buy shares at a low price, and profit when the situation normalizes, quotations rise. The operation is similar to intraday transactions, but the term is unlimited. This is a common practice. It is rational to use less than 25% of assets in this way.
Inverse ETFs (“Exchange Traded Funds”)
Inverse ETFs mirror the behavior of an index. Advantages are that losses are limited to the capital invested, and simplicity, since operations are similar to trading stocks. This tool is only available from foreign brokers.
For example, funds are invested in a reverse ETF with an asset worth $500 (36725 rubles). On the first day the quotes of the asset dropped by 20% to $400 (29380 rubles), on the second day they dropped by 25% to $300 (22035 rubles). Symmetrically, the price of the inverse ETF will increase by 20%, then by 25% to $500 (36725 rubles) 1.2 1.25 = 750 dollars (55087 rubles). The resulting profit is $250 (18363 rubles).
For comparison, if an investor earns on a short position, the yield is equal to the difference in quotes: $500 (36725 rubles) $300 (22035 rubles) = $200 (14690 rubles). When there is a consistent decline in the market, the profitability of the inverse ETF is higher than the return on the short.
Futures for sale
A futures contract is an agreement between a buyer and a seller to deliver an asset (securities, indices, currency) in the future, or to pay the difference between the contract value and the price of the underlying asset in the future. The parties decide when, at what price, the transaction will occur. The value of a futures contract differs from the current quote of the asset, called a “spot.”
One party will make money if the price of the asset falls; the other party will lose. If the value of the futures is lower than the underlying asset, the situation is called a “backwardation.”
Futures are a leveraged instrument that allows you to make more money. It promises profitability, but it also leads to losses.
Futures are used in a hedging strategy to protect against unfavorable changes in an asset’s quotation. If you have bank stocks in your portfolio and a decline is expected, you should open a “short” position in the futures on the bank’s securities. And the income from the futures will make up for the losses from the stock decline.
CFD (“Contract for Difference”) is a transaction without possession of an asset, with the parties agreeing to pay the difference between the buying and selling price. If a stock trades at 10 euros, the price of a CFD paper is close to 10 euros. Unlike options and futures, CFDs are not time limited. CFDs are used for long and short positions, bullish and bearish. You can short a CFD, benefiting if the price of the asset falls.
CFDs do not require the payment of the full price, only the collateral for the leverage. Profits are greater than trading with your own cash, but high losses are possible.
The European regulator ESMA considers CFDs to be unprofitable in 90% of cases.
Warrants are quoted products that give the right to buy (warrant call) or sell (warrant put) an asset up to a certain date at a fixed price called the strike price. The investor pays a commission in exchange for this right, it is a maximum loss.
To prevent a decline in the stock price, “warrant puts” are bought. They provide leverage, although the loss is limited to uncommitted capital. The downside of put warrants for traders is that they are issued by the entity issuing the securities. Therefore, if the stock price falls, the bankrupt will not repay the put warrants.
U.S. warrants are exercisable at any time before the expiration date. And European firms’ warrants are received on the last day of the expiration date.
Binary options trading
The instrument is considered a bet based on an agreement to buy or sell (“call”, “put”) assets at a predetermined price at a specified time. You can bet that tomorrow the dollar/euro exchange rate will go up. When it rises, a profit is credited to your account. If it does not change, the funds will return to the personal account. If it decreases, the bet is lost. For players it is a salvation in the situation of falling of quotations.
Binary options work with underlying assets. A security is selected and a bet is made on a falling quote. The investor does not have to actually buy or sell the stock, just speculate on the fluctuations in their prices.
The instrument is banned in Europe, but is popular in Latin America. The game is unprofitable. The potential winnings are less than the possible profits. The average profitability of the transaction is 80%. If a trader bets ten dollars and wins, he will receive eight dollars. If he loses, he will lose ten dollars. To make up for an unsuccessful attempt to win will have to win twice. Winning half of the transactions, the player will suffer a loss.
The bottom line
The market uses different ways to make a profit when the price of an asset falls. Investment instruments are used cautiously, for example, to hedge part of the portfolio. Risks are also associated with the use of leverage. The products mentioned are complex, application requires knowledge and experience.
Exchanges rise most of the time, it gives room for maneuvers. Market declines are fleeting, time fails traders.
A shrinking market carries many risks. You need to use “stop losses” for short positions.
Market-neutral strategies using short positions
Market-neutral strategies refer to low-variance financial plans with the least amount of exposure to fixed stock market risk.
Market-neutral strategies are divided into four basic techniques:
- Arbitrage – based on obtaining proceeds from multiple agreements linked on a single savings. Contracts are negotiated on one or more exchanges. The contract is for securities and any secondary mechanism. The main aspect in litigation deals is interconnection. The ideal result is more than 90%;
- Pair trading is created on the application of the fact that the prices of certain stocks change. Certain stocks are interconnected with each other by some source. For example, two different organizations are able to cooperate in the same industry, and the value on their savings will be conditioned by fluctuations in that industry. Shares of such securities are correlated, and savers and traders apply this correlation in commerce. The paired strategy uses an unlimited number of assets;
- Basket trading – trading one or more tares of related vehicles. Features – variety of threats by several mechanisms and probability of formation of market-neutral portfolio, allowing to earn in various exchange conditions independently from certain trend direction;
- Volatility trading – the level of fluctuation in value or profitability of savings. This technique is based on the movement of prices. There is also buying and selling, but the trader’s gain is based on how much the market moves. It doesn’t matter in which direction.
This methodology uses market options for initial savings, futures contracts and targeted investment funds for volatility.
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