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.
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.