Make Money When Stocks Fall

I know that we have seen some impressive gains over the past several months in the stock market.  That is why it is especially important to learn about different strategies and techniques that you can use to make money when the stock market begins to decline.  Inevitably, stocks will decline and when they do so, they tend to do so rather quickly.  Those who are well prepared can take advantage of the decline to hold on to their previous gains or even make additional profits on the way down.

When most people think about investing in stocks, they think about buying a stock at a particular price and selling at a higher price in order to make a profit.  They can easily understand the concept of buy low and sell high as a way to make money in the stock market.  However, there are several ways to benefit from a falling stock price which are not readily apparent.  In this article, I would like to discuss 4 different ways to make money when stocks decline after a positive run.

This is the most obvious method of making money when stocks decline.  Instead of buying low and selling high, the order is reversed.  Sell when the shares are high and buy back when the shares are low.  The shares are actually borrowed from another investor who is holding them long term.  It is really an accounting entry where the stock broker keeps tabs on who has borrowed what from whom.  When you buy back the shares to close out the trade, they are returned to the lender.

One of my favorite ways to profit if a stock declines in price is through buying put options.  I usually already own the stock and want to protect profits more than anything, but I will occasionally buy extra puts after a large percentage gain in a particular stock since I know that many investors will sell the stock to take some profit.  When the first group of investors starts to do this, the stock will decline and so others will not want to lose their gains and will sell as well.  By holding the puts, I can make some quick money on any retreat.  Of course, you don’t need to own the stock to buy put options on a stock.  You can do this for any stock which has options available that you think might be overpriced.

The other method that I like to use to make extra money when a stock has made a big run to the upside is to sell call options.  I know that most stocks aren’t going to go up in a straight line, so if there has been a big jump, there will likely be a pull back and some consolidation.  You could buy some put options (see #2 above) but this method allows you to deposit money in your account rather than spend it.

I use this technique for stocks that I plan on holding longer term.  I am essentially trading around my core position.  For example, I hold Goldcorp stock (symbol GG) in my 401(k).  I plan on holding the stock for several more years since I feel that precious metal exposure can help decrease the overall volatility of my portfolio.  I may sell some of this stock when it hits a specific price and wait for a pull back to replace those shares which lowers my overall cost over time and enables me to grow my position in the stock.  I recently sold some shares outright at $43 per share and can buy back when the cost per share decreases.

These are just some of the simple techniques to make money when stocks decline in price.  There are more sophisticated option techniques with spreads, but I wanted to keep this article fairly simple that most investors would understand and be able to accomplish when the next bear market strikes.