Tuesday, November 8, 2011

Smart Strategies to make money in falling markets

With the stock markets world over being as volatile as it is now, investors are looking for smarter ways to make money even in falling markets. If you are one of those investors, then this post is for you.

Although we believe it's probably best during volatile markets to maintain a balanced portfolio or stick to debt instruments until the markets get on the Bull again, there are potential ways to make some money even in such volatile/falling markets.

Note: Some of these strategies may be extremely risky for novice investors and you are hereby requested to do your research and invest only on your own risk.

Some Smart Stretegies:

1. Switch to cash or currencies

The easiest approach of all is to switch to Fixed Deposits. Banks in India are offering around 9% or more these days plus it is safe and secure. Another option would be to park the surplus cash in your bank account until the market stabilizes.

This is probably the best approach for Risk-Averse/Novice Investors. However, it is not a wise idea to let cash lay idle in your bank account. Instead a Fixed Deposit will atleast give you decent returns.

2. Switch to gold/commodities

Gold, other precious metals, oil and soft commdities (such as wheat futures) can be safe havens or even highly profitable in times of crisis. Gold is probably the best bet for investors who are not too sure about investing in the commodity markets. Gold has been one of the best performing asset classes of all times and would be a good addition to your portfolio.

To learn more about Historic Demand for Gold and the Historic Price Movement of Gold in the past 2 decades, you can Click Here

To learn more about Investing in Gold and other precious metals, you can Click Here

To learn more about Gold as an Investment, you can Click Here

This would be a nice option for Risk-Averse/Novice Investors. However, a point to note is that the price of gold too can fall and can cause losses in the short term. However, as a whole the price of Gold will always go up and you can expect decent profits in long term.

3. Buy when stocks are cheap or Average out your prices

Stock Market crashes can create great buy opportunities for the smart investor. Stocks of even the top performing companies fall when the market crashes. Though, they are company's with solid fundamentals and good profit making capability, their stocks fell just because of the negative investor sentiment. Such times can be a nice time to enter the market and buy stocks that have a proven track record. If you are someone who bought shares of a good company sometime back and are worrying because the market is bottoming out, you can go ahead and average out your costs by buying more of those stocks. This way, your average investment per share will come down and you can make better profits when the market rebounds.

Buying shares when the market is down is a risky strategy and you may lose your investment as well. So, you need to be cautious while buying at such troubled times. If you are uncertain about which stocks to pick, the best approach would be to pick out the best performing Equity Mutual Funds and let the Fund Manager do the thinking.

4. Do Short Selling

Short Selling is a Derivative Strategy that you can use to make profit when stock prices fall. Let us look at a Scenario.

Step 1: You expect that Shares of ICICI Bank are going to fall next week once their quarterly results are out. Lets say the current share price is Rs. 1000 per share.
Step 2: You Initiate a Short Sell request for 10 shares of ICICI in the stock market (You are selling 10 shares that you do not own). You will get Rs. 10,000/- for the sale transaction under the obligation that you will buy it back after some days.
Step 3: Lucky for you, the price of ICICI has indeed gone down after 2 weeks. It is trading at Rs. 900 per share.
Step 4: Now, you buy the same 10 shares of ICICI for Rs. 9000/- and settle the trade with your broker. This is what happens when you finish the buy
1. You literally bought back the 10 shares you did not own and now your broker has no fake shares on your name
2. You pay your broker the price @ Rs. 900 per share which is Rs. 9000 and complete the trade
Step 5: Since you fulfilled your obligation of buying back the 10 shares the Short-Sale transaction is complete. You got Rs. 10000 for the sale and paid Rs. 9000 for the purchase two weeks later, leaving you with a profit of Rs. 1000

In Short "You successfully sold shares you didn't own, then bought the shares back at a cheaper price, thereby pocketing a profit."

On the contrary, if ICICI had gone up to Rs. 1200 after 2 weeks, you still would have to buy back those 10 imaginary shares you sold thereby paying Rs. 12,000 to your trader which essentially means you are losing Rs. 2000 from your pocket. It would have been better if you had just purchased ICICI shares on day one instead of placing a Short-Sell order.

A point to note here is that, your trader will expect some Margin Requirements in order to fulfill such trades and the above is just a hypothetical example with no strings attached.

This is an extremely risky proposition. Novice or Risk Averse investors should stay away from such transactions because if the price of the shares go up, you still would have to buy back the shares at a later point in time and you will end up losing money instead of earning it

5. Buy Puts

A Put option (sometimes simply called a "Put") is a financial contract between two parties, the buyer and the writer (seller) of the option. The Put allows the buyer the right but not the obligation to sell a share to the writer of the option at a certain time for a certain price (the strike price). The writer has the obligation to purchase the underlying asset at that strike price, if the buyer exercises the option. The buyer pays a fee (called a premium) for this right. The Put buyer either believes it's likely the price of the underlying asset will fall by the exercise date, or hopes to protect a long position in the asset. The advantage of buying a put over shorting the asset is that the risk is limited to the premium.

Unlike the short-sell scenario just explained in the previous paragraph, you are not expected to buy the shares in case the prices go up. Instead you just let the Put-Contract expire and limit your losses to the premium you paid. However, if the price of the shares fall, you can purchase them and try to make a profit.

This again is an extremely risky proposition. Novice or Risk Averse investors should stay away from such transactions

Even if the stock market is volatile, there are options for the smart investor to make money. However, it carries a lot of risk and Novice Investors must stay away from such complicated Derivative products unless they are willing to bear the losses that may arise.

Happy Investing!!!

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