The layman is taught you can only make money in an up market, that you should buy to hold for the long term for your retirement, and that you need to ride out loses as the markets fall.
Well that just isn’t the case, let’s break this down.
Up Market (Bullish)
- Buy a stock – This is probably the most common understanding of the stock market which is where you buy a share in a company with the hope that the company increases in value.
- The downside of this approach is that you need 100% of the capital to purchase the stock tying up your capital for a significant period of time (with the exclusion of margin accounts which require large amounts of capital)
- Buy an option to purchase stock (call option) – Options provide you with leverage therefore only tie up a small amount of your capital. As the value of the underlying stock goes up so does the value of your option. You can now sell your option since it is worth more and you never even have to buy the stock
- Sell an option to purchase stock cheaper (put option) – This can be compared to selling insurance on a stock. Comparing to car insurance, (you) the insurance company receive a premium to protect the car from damage or theft (i.e. a decline in value). Similarly for stock you receive a premium to protect the price of stock falling, therefore in a bullish (up) market the buyer won’t need to call upon you to compensate for the loss in stock value and you therefore get to keep the premium.
There are many more option strategies for up (bullish) markets but we won’t go into them here.
Down Market (Bearish)
You don’t need to ride out your losses. If you did this in 2000 you would have only made back your losses by 2008 just in time for the next big crash! From there it would have taken another 5 years to make back those new losses, so you’d only just be back at square one.
Here’s how you can make money in a down market:
- Shorting stock – This means to sell stock which you don’t own, you would borrow it from your broker, sell it in the market and buy it back at a lower price. (Similar to buy low and sell high, you can sell high and buy low)
- Sell an option to sell stock at a higher price (sell a call) – you make a promise to sell a stock at a higher price, so in a down market the buyer won’t call you out on the promise and you get to keep the premium
- Buy an option to insure your stock portfolio (buy a put) – as I mentioned above options can act as insurance, so if there is a down market you can buy insurance to protect your current gains
Also known as stock in a box, this is where the stock price is going sideways oscillating between a high and low price. You wouldn’t want to buy or sell a stock in this case as you don’t know in which direction the stock will move.
- Buy & sell options outside the box (Iron Condor) – this is a great cashflow trade that we use regularly. We buy and sell well outside the high and low of the stock, if the stock should break outside of the box we then adjust and risk manage the position.
Hopefully the above examples go to show how a sound education can help you make money in any type of market, that buy and hold isn’t the only strategy and you don’t need to accept losses, thereby maximising your profits.
**This does not constitute a recommendation or financial advice and is intended for education only**