Can Declining Stocks Still Make Money?
There is a little secret that is totally unknown to the new investor and even the average investor. That secret is that you CAN make money on a stock no matter what it is doing!! To be more specific, I’m saying you can make money if a stock is going up (the most popular way) in price. You can ALSO make money if a stock is staying flat OR even if the stock is going down in price.
Make Money on declining stocks by Short-Selling
You can make money when stock prices drop by implementing a strategy called short-selling. You can also buy put options on a declining stock or set up some options spreads.
If the stock is flat you can implement some short-selling options strategies. However, I would NOT recommend flat out buying a put option. Actually, ONLY buying a put or call option on a stock that is flat is a very bad idea and a sure way to lose ALL your investment in that trade.
I cover different options strategies on my site, so to keep this short and simple, I will just focus on the concept of short selling, or you can check out my other article on options.
Short-Selling vs Long Buying
First let’s discuss the differences and similarities between a “short” position and a “long” position. With a long position you buy something today and hope to sell it at a higher price for a profit tomorrow. With a short position, you borrow money to SELL something today and hope to BUY it back at a lower price tomorrow. With both long and short strategies you are buying low and selling high. The difference between the two is that the order is reversed. With one strategy (long) you buy first and with the other strategy (short) you sell first.
Another major difference between short-selling and long-buying is that when you are long you can hold on to a stock forever. With a short position this is technically a loan since you sold stocks you don’t already own. what this means is that at some point you will be “required” to close out your position and in extreme cases you could be “forced” to do so via a margin call.
Also, with a long position your risk is limited to the amount you paid for the stock. For example, if you bought 1000 shares of stock at $25, your max loss is $25,000 if the stock drops to $0. With short-selling, let’s say you shorted (sold) 1000 shares of a stock at $25. Your initial cost is $25,000 but your max loss is unlimited. This is because there is no limit to how high a stock can go and eventually you will have to buy it back. For example you sold 1000 shares of the stock at $25 and the stock goes to $100 per share. You will be required to buy 1000 shares of stock at $100 to satisfy your short position. This is the big risk with Shorting Stocks outright.
Not to worry, like I said earlier you can greatly reduce your cost AND risk by buying a put option on the same stock.
As you can see, you can make money in ANY market condition, you just need to pick the right strategy (and stock) for the particular market direction. The short strategy works perfectly in a declining market because YOU WANT PRICES TO DROP. On the flip side, you do not want to short a stock in a rising market.