How would one profit from a share price falling, granted that they correctly predicted it would happen?
Say I had a hunch that a certain stock was going to fall next week, how could I effectively make a profit on this.
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20Related: how to lose BIG by betting on falling prices– WernerCDCommented Jan 24, 2018 at 3:12
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5I believe the term you're looking for is "short selling".– Dmitry GrigoryevCommented Jan 24, 2018 at 9:54
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Also related: What's the best way to make money from a market correction?– martinCommented Jan 25, 2018 at 6:24
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4 Answers
The three normal ways to profit from falling stock prices are:
Short sale: Borrow someone else's shares. Sell at current price. Wait for price to fall. Buy back at lower price. Return shares to owner. This has unbounded upside risk should share price increase significantly.
Sell/write call options with strike price above current share price. If share price does not rise above the strike price, the calls will expire and you will keep the money made from selling them. If the calls are naked, the risk above the strike price plus premium received is the same as being short the stock.
Buy put options with a strike price lower than current price. When stock drops below strike price of put, either buy shares at new low price and exercise the option to sell at a high price, or sell the option. The most you can lose is the cost of the long puts.
All three of the above are risky, especially for a novice investor and are not recommended to anyone without significant experience and understanding of derivatives.
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17I think he's saying that's how it works, but me personally (since I had to ask) shouldn't do it. I would edit it to say "these are the methods... but one who has to ask, probably shouldn't do it"– WelzCommented Jan 24, 2018 at 0:05
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11@D Stanley: These are three ways to profit from a falling stock, but two of those methods carry significant risk if you are wrong. So while you could, if you are asking the question you should not– RockyCommented Jan 24, 2018 at 0:17
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26Great info, but I think there is a better way to explain the risks than to be patronizing. Everyone who knows something started by not knowing something and asking. Commented Jan 24, 2018 at 6:39
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5I've modified the patronizing bit while retaining the significant (and justified) warning tone. "If you have to ask..." is never appropriate in my opinion; that suggests people should not do research, and assumes they will make poor choices rather than they are asking for basic information to build their knowledge. Asking a basic question certainly justifies a significant warning, but not the patronizing tone.– JoeCommented Jan 24, 2018 at 17:02
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6@joe "If you have to ask" is accurate here. The point is that if you are asking about this, this means you don't know enough to safely do any of these at this point. You should be well past the point of understanding these choices exist before you should consider doing them.– YakkCommented Jan 24, 2018 at 18:02
You can short sell shares, buy put options or write call options as noted above, but make sure you have stop loss orders in place if you are going long or short.
Another method you could use to also profit from a falling market is to buy bear ETFs (Exchange Traded Funds), you can use these to trade the market as a whole or to profit from falling sectors or whatever else might be covered by bear ETFs.
And if you are not in the US, you can trade CFDs (Contracts For Difference), which you can go both long and short in. But again remember to not overtrade (as CFDs use margin) and to use stop losses appropriately.
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I think "bear ETFs" is a good and unique element of this answer, and it might bear a bit more of explanation.– JoeCommented Jan 24, 2018 at 17:09
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1@Joe - simple just as the name suggests, for eg. if you buy a S&P500 Bear ETF and the S&P500 index falls the Bear ETF will rise in price and you make money.– VictorCommented Jan 25, 2018 at 9:07
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@Victor I know what it means, but given the simplicity of the question I think it might justify some explanation in the answer (a paragraph or two). It's what your answer really brings to the table. (Also, some note about the disadvantages of bear ETFs versus regular ones - seeing "ETF" might make someone think it's a totally safe thing that's reliable in making money...)– JoeCommented Jan 25, 2018 at 15:57
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@joe - are you trying to say that standard ETFs are totally safe and you can't lose money with them? You can lose money with any investment just as you can lose money with bear ETFs.– VictorCommented Jan 25, 2018 at 22:43
You can profit from a share price falling by what is known as shorting the stock. Effectively you borrow the stock from a broker willing to loan it to you at the current price then 'sell' it back to them when the price of the stock falls. The difference is yours to keep.
Be warned however this is a risky position to take as it now exposes you to theoretically infinite losses if the stock moves the other way. When you're 'long' a stock, you can only lose the money you spent on it.
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8@CraigW It's an even better example of what can go wrong when you look up their current price - he was absolutely right, and the stock cratered down to a current $0.40 value. He just wasn't right at the right time.– ceejayozCommented Jan 24, 2018 at 2:23
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8"Markets can remain irrational longer than you can remain solvent." Commented Jan 24, 2018 at 21:48
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Answer unclear. To clarify, when you short a stock you borrow the stock from your broker or through your broker. Then you sell that stock on the market. If the price drops (rises), you buy it back at a lower (or higher) price and return it to the broker with interest (unless you're daytrading). The difference is your profit (loss). Commented Jan 26, 2018 at 2:43
Ways to benefit if a security is dropping:
1) Short the shares if they are borrowable and the borrow fee isn't huge. This requires a margin account. Borrow fees can be as low as 0.25 pct or crazy numbers like 50-75-100% per year. Buy them back for a profit if price drops. Buy them back for a loss if they rise.
2) Buy put options. To capture smaller moves, buy ITM puts. They will lose more than OTM puts if you are wrong. For leverage, buy OTM puts. If you get a big move, the ROI is higher than with ITM puts. If wrong, you will lose less (on a 1:1 basis). The delta of the option will tell you how much the option should gain (or lose) per point of stock movement. Delta is non linear and affected by the level of implied volatility so keep in mind that it's an approximation.
3) Sell/write covered calls. If they expire, you keep the money made from selling them. This is more of an income proposition and unless the calls are deep ITM, they will hedge the underlying poorly (small premium against large underlying drop). And as the stock drops, you may find yourself in a position where there is no strike price that you can write without locking in a loss.
(1) (short stock) is the only dangerous choice.
(2) (long puts) has limited risk.
(3) is an opportunity risk if the price rises and you are assigned and must sell the stock at the strike price (you don't participate in the upside).
If you want a global approach, you can buy inverse ETFs but they bear a similar risk to shorting.
Shorting is risky and should only be don by those who are experienced and who practice good risk management. While it is true that there are "theoretically infinite losses if the stock moves the other way", that's just not reality. No stock has ever gone to infinity and no big cap stock will ever do this. You manage a short position just as you manage a long position.
answered Jan 27, 2018 at 16:32
