Over the last few weeks, I have been alluding to the fact that we can make money while markets are falling. Many people have heard about it, but very few people actually do it. So what exactly is Selling Short? How can you make money when markets go down?! Over the last few months we have been sharing with you ideas on how to buy into stocks. But what about making money when markets go down? Now here’s a great concept. We don’t have to stand by watching our money dwindle as markets go down; we can jump in and make money as they do so.
So everyone knows that the idea of making money is to buy near the bottom and sell near the top. But what is so great about the Buffalo strategy we have been writing about is that we can actually go one step further. We also do something called ‘sell short’ near the top. This is a way of actually making money when markets go down. So we sell short at the top and buy back at the bottom and the middle is the profit.
In other words, while most people are losing money when markets go down, we are actually making money. Most people don’t understand how to make money when markets go down, which is a shame because they are missing out on almost double the trading opportunities and chances of making money.
So this has to be part of your trading arsenal for sure – selling short almost gives you 100% more chance of making money. And also stocks tend to fall faster than they go up. So you can make money faster. Why? Because people tend to panic as markets go down so everyone starts to exit their trades. So the stock goes down further, making even more people panic and so it continues. That is why they say that Bulls walk up the stairs (slow) and bears jump out of the window (fast). Large institutions are aware of this so they drive down prices even more, to shake everyone out before they get in.
Now some people get confused by this concept but in reality if you look at the graph above we are still Buying low and Selling high (see above) and when you do that you make a profit. How else can you make a profit other than buying low and selling high? The only difference is the order in which we do this. Normally we buy first and then we sell. When we are making money going down, we sell first and as it goes down we then buy it back. Can you see that in this way we are still buying low and selling high? Only when we Sell Short we are doing the selling first.
Now the immediate reaction for most people is
“But Marcus, how can you sell something you don’t own?”
Good question. The answer is, “You can’t”. But as soon as you press that button called ‘Sell Short’ the broker automatically lends you the stock which you then automatically sell to the market. Then at some stage you have to buy it back to give back to the broker who lent it to you.
Let’s take an example. Take a look at the graph above. If you thought that Intel was high at 31.75 because it had fallen at that level several times, then you might be tempted to press the ‘Sell Short’ button. As soon as it falls you are in profit. At some stage you want to realise your profits, if possible as close to 27.25 as possible. That would be a great trade.
That’s a 31.75 – 27.25 /31.75 * 100 = 14.17% profit.
Please notice that when you were shorting Intel and the price would have gone UP, you would have lost money. In the same way that when you buy a stock and it goes DOWN, you also lose money. That is why when we are trading we always use a stop loss, to ensure small losses and large gains. Remember that a Stop Loss is an automatic order that takes you out of the trade. You don’t need to be there, it is all done automatically by the broker. We always use a stop loss when we trade.
Let’s take another example, a made up example. You are currently in the pen industry where you buy and sell pens, and have realised that the price of a pen does not tend to go over £1. The current price of pens is sitting at exactly £1 and you decide that you want to sell pens, however you have none in stock. You go to some one who will lend you pens (broker) and ask for 1000 pens, which he agrees to give you. You then go on to sell those pens at £1 making £1000 in total, and sure enough the market price starts to fall. The market price reaches £0.50 and you are in profit, and you decide that you want to cash in your profits, in order to do so we need to return the pens to our lender (broker) so that we can cash in on the difference in price per pen. So we buy 1000 pens at £0.50, which cost us £500, we then return the pens to the lender (broker) and we are left with £500 profit.
In the markets this whole transaction is done with a few clicks of a few buttons and the transaction time is almost instant.
Let’s take another example. Let’s say that I had just bought a brand new Mercedes E-250 Sport Coupe. Imagine I left the car with a friend for a year while taking a 1 year vacation around the world. Imagine that this friend sold the car and made £47,000 on the spot. One year later I come back and the first thing I do is to call my friend to get my car back. What does he have to do? He has to buy one in the market place. The price has probably fallen over that time so now they are worth only £37,000. He buys an identical model, puts my number plate back on and gives me the car back. The difference is he has pocketed £10,000 and I am none the wiser.
Still not comfortable with the idea? Ok, do you use a mobile phone? If you do, then how does it work? How does your voice travel into the phone then get beamed halfway across the world so that you can talk to a friend? Don’t know how it works exactly? No. But you still use it don’t you? Yes. Why? Because it works.
There are only 4 buttons
1. Buy and
3. Sell Short and
4. Buy Back
Just practise doing it and make money as markets go down and you will soon figure it out. What a tool to have in your arsenal. You will be making money where normally you would be losing money.