Investing in declining markets

Generally investments in the stock market are made with the expectation that the price of shares or securities are appreciated in the future. That is, it is invested under the assumption that the market will keep rising to capitalize profits.

But the market remains a dynamic institution, is subject to fluctuations either upward or downward, and both situations offer profit opportunities.

Among investors there may be a lot of nervousness when the market starts to fall, but others take advantage of the correction to implement strategies that can otrorgar great benefits as well as losses.

One of the most used strategies in a down market is the short sale.

While true that the term is widely used in the real estate market, also it exists in the market, and is to sell shares or securities, borrowing them from another investor does not possess.

For example, after making a thorough analysis of the company XYZ, you determine that the share price will drop, and therefore decide to pursue a strategy of short selling for 100 shares of XYZ currently trading at $ 20 each . When placing the order, your broker will borrow 100 shares from another investor and place them in your account, they immediately be sold in the market, then credit the proceeds of such sale in your account, which in this case would be $ 2.000 .

Let’s say that after a while the shares of XYZ are trading at $ 15 and decide to close the position. Then you should buy 100 shares at $ 15, so to make your broker debited $ 1,500 your account to run the purchase, will place 100 shares in your account but inmediatamenta the will transfer the investor original owner of such shares for its return. In this example, this strategy represented you a profit of $ 500.

But short sales can also generate losses can be unlimited. Let’s say the stock price of XYZ rather than lose up to $ 25. This means you have to buy the shares at a higher price than the price at which the vendistes. If you decide to close the position, your broker will debit your account $ 2,500, so you’ll need to have enough cash in your balance to cover the loss of $ 500, which you generated the entire transaction.

It is important to take into account the costs associated as broker commissions for each buy and sell order and the interests that the broker may charge for lending the shares. Also, if the borrowed shares generated dividends for as long as you keep the open position, they must be paid to the original owner.

Also as the short sale involves a loan, brokers allow execution as long as the investor maintains a margin account.

Remember that all investment involves risks, some more than others. And in this case, once the order is placed, the investor is subject to the risk that the share price rises to such an extent that losses can be unlimited. So before you start with this type of strategy, it is recommended to make a thorough analysis of the action and not risking too much money at first, to acquire experience levels increase the likelihood of profits.