It's easy to make money when stock prices rise.
Just invest in one of the 5,000 stocks listed on major exchanges or one of the hundreds of exchange-traded funds (ETFs) that are already available - with more being added almost every day.
But if you want to make money when the stock market crashes, it's just as easy.
Maybe even easier.
Just buy shares in one or all of the four "investments" I'm going to tell you about today...
More Pain Means More Gain
Shorting strategies will allow you to cash in when stocks, bonds, or other assets fall in price.
Indeed, there are lots of ways to make money when things go down. But just knowing about the three most popular strategies to play price or market declines is enough for you to cash in on the next stock that plunges on disappointing earnings - or on the next bear market in blue chips.
Those three key "short-side strategies" are:
- Selling short, more commonly known as shorting
- Buying inverse ETFs
- Buying put options
Today we're going to look at inverse ETFs.
Grabbing Profits During a Stock Market Crash
When I talk to investors, one of my main messages is that "there's always a place to make money" - with any kind of asset... and in any kind of market.
And short-selling is a core piece of that belief.
In fact, investors who aren't at least considering short-side trades are missing major profit opportunities - in essence, leaving lots of money on the table.
ETFs are packaged products that trade all day like stocks.
You can buy them... sell them... and short them.
And there are hundreds to choose from.
Inverse ETFs are a category of exchange-traded funds that do the opposite of what an underlying portfolio or index does.
When markets fall, inverse ETFs rise in value. And the steeper the market drop, the bigger your profit.
Here's what I mean...
Outperforming "Mr. Market"
The "stock market" is a generic term for all stocks that trade on a specific market or exchange, in an index or across all exchanges.
Here in the United States, there are different measures - or representations - of what we think of as the "stock market." The most popular measures for "the market" are indexes that track 30 stocks, 100 stocks, 500 stocks, or 2,000 stocks.
You know these indexes as the Dow Jones Industrial Average (a 30-stock index of blue-chip companies), the Nasdaq 100 (a 100-stock index with a tech focus), the Standard & Poor's 500 Index (S&P's broad index of 500 stocks), and the Russell 2000 (an index of 2,000 small-cap stocks).
If you think the stock market, as measured by the Dow, is going higher - and you want to make money on the anticipated rise in share prices - you can buy all 30 stocks in the Industrial Average. You can do the same thing with the Nasdaq 100, the S&P 500, or the Russell 2000.
But there's also a way to cash in on the surge in one of those indexes - get the exact same performance, in fact - and do so without buying any shares in the actual companies that make up the index.
That's because there are ETFs that track each of those four major indexes. You can buy shares in an ETF that tracks any of those benchmark indexes and make money if "the stock market" - as measured by the index you choose - goes up.
As we all know, however, stocks don't only rise in price.
They also fall.
If you owned an ETF that tracked the market, and you began to believe that the market was going to fall, you could easily sell your ETF shares.
That's a "defensive" move - one that would let you keep the profits you'd already booked and avoid the losses that accompany a market decline.
But what if you believed the market was going to go down a lot - and wanted to be opportunistic?
If you thought the market was headed for a substantial decline, you might start by selling the ETF shares you hold "long."
And you'd follow that move by shorting the ETF - selling it short.
Let's face it: A move like this isn't for everyone.
Some people just don't like to short. And some investors can't short because their money is held in an IRA or some other type of account through which they can only buy stocks.
But I see the "short side" as a slice of any complete investing game plan.
And that's where inverse ETFs come into play.
There are all kinds of inverse ETFs, including inverse plays on the Dow Jones, the Nasdaq 100, the S&P 500, and the Russell 2000.
As we've already demonstrated, an ETF that tracks the Dow or S&P 500 goes up in price if the underlying index goes up. And if the underlying index goes down, so does the ETF that tracks it.
As the term implies, an inverse ETF works in the opposite manner. If the Dow or the Nasdaq 100 or the S&P 500 or the Russell 2000 rises in value, the share price of the inverse ETF drops.
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But when the market goes down, an inverse ETF goes up in price. So if the Dow or S&P 500 sells off - and you're holding shares of the associated inverse ETF - you're going to cash in.
That's how you can make easy money when the stock market drops.
Let's take a look at some key examples.
If you're expecting a decline in the Dow Jones, you can buy shares of the DowProShares Short Dow30 (NYSE: DOG), the ETF that rises in price when the widely followed 30-stock, blue-chip index stumbles.
Retail investors follow the Dow. But when looking at broad-market topics, institutional investors tend to focus on the S&P 500. And the ProShares Short S&P 500 (NYSE: SH), is an inverse ETF that goes up in price if the S&P 500 does down.
Let's say you're concerned about tech stocks, which have experienced quite a run. The Nasdaq Composite Index set a new all-time high late last month and has zoomed to a 20.5% gain over the past 12 months - close to double the 11.5% advance posted by the S&P 500.
To pull down profits if tech stocks nosedive, you can buy shares of the ProShares Short QQQ ETF (NYSE: PSQ), an inverse ETF that goes up in price if the Nasdaq 100 goes down.
There's also the small-cap sector, represented by the Russell 2000, an index whose 7.6% return over the last 12 months has lagged both the Nasdaq and the S&P.
If you're projecting a sell-off there, you can buy shares of the ProShares Short Russell2000 (NYSE: RWM), an inverse ETF that goes up in price if the Russell 2000 goes down.
Each of these inverse ETFs is designed to move about as much, on a percentage basis, as the underlying index it tracks - only in the opposite direction.
Besides regular inverse ETFs, there are "leveraged inverse ETFs" that move two times and three times as much as the underlying indexes they track.
These leveraged inverse ETFs are not as straightforward as the conventional "1X inverse ETFs" that we've talked about here today. Indeed, they can be quite tricky, so I'll get into them another time.
But the lessons we've talked about today are straightforward.
Making money when the markets go down can be easy - especially when you use inverse ETFs to make your trades.
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.