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Is It Possible To Make Money In A Down Market?
Written by Michael Thompson
The market seems to be only going downwards. It is as if the market has only one direction to move. That is why many investors are confounded by the question, is it possible to make money in a down market?

Most investors and traders are familiar with just buying stocks and other assets and holding them. They sell off assets when the price moves higher. However, it is indeed possible to do the opposite as well. That is what we will highlight below.

Is it possible to make money in a down market?

The answer is yes, it is possible to make money in a down market. There are essentially two ways to do so. We will go into the details of both of them below.

1. Shorting the market

The normal process of buying stocks or index and selling it off at a higher price one is going long on the asset price. While, if you want to make money in a down market, you have to do the exact opposite.

You have to first sell the stock or the index. You might be thinking about how you can sell a stock which you have not bought.

The answer is by borrowing it from the broker. When you sell the stock directly without having it in your portfolio, the broker borrows you that stock to sell to someone else. Executing such a trade can result in a deficit.

Your portfolio or trading book would show you a negative balance for that stock. For example, instead of showing that you hold 100 quantity of a particular stock, it will show you minus 100. It is because you have borrowed the stock, and you have to fulfill that deficit.

Now that you are aware of the shorting mechanism, the question which comes is how to make a profit by selling the stock first and buying it later?

The answer is by buying it at a lower price.

For example, if you sell 100 quantity of a particular stock at let's say 11 am at $ 105 and buy the same at 2:30 pm at $ 100, you have essentially purchased the stock at $ 100 and sold at $ 105. As a result, you make a profit of $5 on every stock.

While you can short the stocks directly by selling it but if you want to short the index or the market, you can do so via the ETF route

How is it different from going long?

There are two differences between going long and short.

The difference in trading mechanism:

The normal trade of buying first at a lower price and selling later at a higher price is known as going long on the market or stock.

The only difference between going short on the stock and going long is that you would sell first and buy later when you go short. To sell first without having the stock in your portfolio, you would be borrowing it from your broker. You would close that by buying the stock and giving it back to the broker.

It is the primary difference between going short and going long.

Margin requirement:

Normally, when buying an asset you will have to pay the amount equal to the quantity which you buy multiplied by the exact value of the asset price. Even if you're trading intraday, the maximum amount you need would be equal to this quantity (unless the broker provides you with margin). The maximum amount of money you can lose when you go long is equal to the amount of the asset price multiplied by its quantity.

For example, if you're buying 100 stocks of a company worth $ 50 apiece, the maximum amount of money that needed is $ 5000. That is why you would first deposit that money in your broker account and then execute your trade.

The case is exactly the opposite when you're going short. When you're shorting selling 100 stocks of a company at $ 50 a piece, it can even rise to $ 200. In that case, you would be losing $ 150 on a single stock. The loss can be almost infinite as the stock can go on increasing. Due to this very reason, most of the brokers require you to have at least double the trading amount in your account before initiating a short trade. In the above example, most brokers expect you to have at least $ 10,000 to initiate such a trade.

As you can see, the margin requirement is different when initiating a short trade than a long one.

These are the two major differences between going long and going short.

Now that you are aware of the first method, let us look at a second one, which will allow you to make money in a down market.
2. Buying Put Contracts:

The first option that we have highlighted above is not the only option for making money in a down market. Another choice which you have is to buy put contracts. Before we go any further, let us first describe what exactly put option contracts are.

What are the put option contracts?

The put option contract allows you to short the asset. You short asset with the expectation of a predetermined price with which the put option contract is associated with. It is known as the strike price.

For example, let's suppose you are buying the put option contract of Nasdaq 100 of 9000 index level, at $ 50 when Nasdaq 100 is at 9600. Now is the NASDAQ 100 modes towards 900, the price of the put option contract's price will increase. The maximum price appreciation would be when NASDAQ 100 hits 9000 index level. When the put option contract's price increases to say $ 70 because of NASDAQ 100 falling to 9300, you can sell it and earn the difference as profit.

You can buy the put option contract of almost every rounded off-market level. The only caveat is that put option contracts are valid for an only predetermined time. After that, their value erodes.

Nonetheless, the put option contracts are one of the best ways to make money in a down market. As the underlying asset prices reach closer to the strike level, the value of put option contracts appreciates.

The best thing about put option contracts is that you can invest in such contracts for any asset like:
  •  Stocks
  • ​Currencies 
  • ​Commodities
  • ​Indexes
  • ​And so on....
It means that in a down market, there is no dearth of opportunities. You can make money not only on depreciating asset prices of the stocks, but also you can do the same for the index. As a result, you can make money in a down market.

One thing which you have to keep in mind is that put option contracts are sold in lots. You cannot just buy a single put option contract. You will have to buy the entire lot. The lot can consist of rounded off quantities like 50, 75, or 100 depending on the asset class. Accordingly, the amount of money that you need to invest in the trade will vary.
To conclude, if you're looking for ways to make money in a down market, these are the two ways to do so. The number of opportunities you get is enormous once you are clear about the basics of exploiting opportunities in a down market. You can make money trading both ways.

About Author: 
Michael Thompson

Michael Thompson is an advanced senior trader with over a decade of trading insight. He has traveled to trading seminars all over the world including Ireland, Germany, Thailand, California, Florida, and Costa Rica....His trading style is centered on accelerated growth. Michael prefers trading a combination of different options strategies.

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