When people think about investing, they often consider buying things like stocks, mutual funds, or ETFs, hoping they'll go up in value so they can sell them for a profit. But if they drop in value, you might end up losing money.
However, for those who believe the stock market is going to go down, there are ways to make money from that prediction. This allows investors to profit whether the market goes up or down.
In this article, we'll explore some simple ways to make bets against the market. While there are many strategies to profit in a falling market, these methods provide an easy starting point for beginners.
Betting against the market is when you invest to make money if the stock market or a certain investment goes down. It's different from buying shares, where you hope their value goes up.
Short selling is a common method to bet against a stock. Here's how it works: You borrow shares from someone and sell them right away, agreeing to return the shares to the lender at a later time.
If the share price drops after you sold them but before you return them, you can buy them back at a cheaper price and keep the profit. But if the price goes up, you'll end up paying more and lose money when you return the shares.
Usually, when people short-sell stocks, they borrow them from their brokerage. Then, the brokerage takes money from the investor's account to pay back the loan automatically.
There are various ways to bet against the market, with some being more complex than others. Here are some of the usual choices.
Some mutual funds and ETFs are called inverse or bear funds. These funds work similar to regular ones, allowing people to buy shares. But the aim of a bear fund is to increase in value when the market goes down. They achieve this using tools like swaps. For instance, if the S&P 500 falls by 10%, a bear fund linked to it should go up by about 10%.
Bear funds are considered less risky for betting against the market because they're not too complicated and don't involve excessive borrowing. However, they can be more costly to manage compared to regular funds that own shares in companies. This extra expense is due to using derivatives to make money when the market drops.
Remember, though, that historically, the market tends to go up over time. So, it's not advisable to hold these funds for the long term.
It's important to know that historically, the stock market has been up more often than down by a significant amount of time.
A put is like a ticket that allows someone to sell shares of a company at a set price, but they don't have to if they don't want to. For instance, you could buy a put that lets you sell shares of XYZ at ₹35 anytime from when you buy it until June 30th.
When you get a put, you pay a fee to the person selling it. This fee is the most you might lose from the deal. If you decide not to use the option, you lose the fee you paid and won't earn anything.
In the situation mentioned earlier, if the price of XYZ stock goes under ₹35, you can use the option and make money. You'll purchase shares at the current market price and then sell them for ₹35 each.
Usually, options are for 100 shares. To calculate your profit from buying a put, the formula is:
((Strike Price - Market Price) * 100) - Premium Paid = Profit
If you paid ₹65 for the option and the stock price drops to ₹30, your earnings would be:
((₹35 - ₹30) * 100) - ₹65 = ₹435
Buying puts is like betting against the market because they become more valuable when the share price falls below the option's strike price.
Futures are similar but different. They're contracts where two parties agree to do a deal at a set date in the future. Unlike options, futures must be acted upon.
With futures, you can bet against the market by agreeing to sell a security at a lower price than its current value. If the security drops below that set price when the contract ends, you make a profit.
ETFs work similarly to mutual funds as they own shares in many different securities. They allow investors to buy shares in just one ETF, making it simple to have a diverse investment.
Different ETFs focus on various market indexes, the overall market, or specific industries. If you think certain sectors or the whole market will drop, you can bet against them by short selling ETFs. To do this, you'd short sell an index ETF or one that concentrates on a particular index.
Short selling ETFs has an advantage because it spreads out your risk, making it safer than short selling just one stock. It can also cost less compared to paying fees for investing in bear ETFs.
One downside of short selling is the risk it carries, which could be infinite theoretically, because the ETF price can rise without limit. Additionally, some ETFs might not have enough available trading volume, so it's better to select a well-known ETF for short selling to make it more effective.
There are various ETFs that help you bet against the stock market. One well-known choice is the ProShares Short S&P 500 ETF. This fund aims to perform opposite to the S&P 500 index. For instance, if the S&P 500 falls by 1%, this ETF seeks to gain 1%.
There isn't a one-size-fits-all method to bet against the market. The strategy you choose depends on what you want to achieve with your investments and how much risk you're comfortable with.
For instance, bear ETFs are easy to use and quite popular. On the other hand, short selling or using derivatives can help you amplify your investments, which raises the risk but also potentially increases the rewards.
Buying a put is a way to bet against a stock or security. Sometimes, betting against a security is casually called "shorting" it. But buying a put is not the same as a short sale, which is another way to bet against a stock. Short selling means selling shares you borrowed, aiming to buy them back later to return to the lender.
Remember, The Balance doesn't offer tax, investment, or financial services or advice. This information is given without considering the specific needs or situations of individual investors and might not be suitable for everyone. Investing has risks, including the chance of losing money.
