Recession | How To Profit From A Stock Market Crash by Selling Short (Part 2)

Commonly people buy the stocks of a company in order to make money as the stock rises in value. This is also known as “going long”.

However, selling short is the method whereby you can make money when stock prices are falling. This is known as “going short”. This is often viewed as risky by many people. In reality, during a bear market when stock markets are falling, buying stocks or “going long” is actually far more risky (as explained in my previous article).

In this article and in the above video, I am going to show you, in simple language, the basics of how you make money as stock prices are falling by selling short. It is actually quite simple to understand.

A Simple Example:

Imagine your best friend has just bought himself a brand new Mercedes. He is also about to leave for a 6 month vacation to the Bahamas. He asks you to look after his car for him while he is away. You happily agree.

Now, you could drive his brand new Mercedes around for 6 months, but instead here is what you do:

1) You sell his brand new Mercedes for $100,000 (keeping the figures simple)
2) You keep the $100K safely in a bank
3) 6 months later your friend calls you up saying he is about to return
4) You go back to original buyer to buy the car back.
5) But wait! The car has depreciated in value after 6 months. It is a used car.
6) So now you buy it back for, let’s say, $85,000
7) You return the car to your friend – he is happy… and You pocket the difference of $15,000.

In other words you just made money from a car you never owned in the first place.

Selling Short:

The method for selling short in stocks is not all that different from the above example.

Let’s say in May 2008, during the last recession, you had looked at the stock chart (see below) of Ford Motor Co.(F). Let’s say you had noticed a signal or pattern on the charts that said this company is in trouble and it is about to crash (in fact, this is much easier in a recession when most companies’ share prices tend to fall anyway).

ford motor stock chart

You call your broker and ask to sell short 1000 shares of Ford at $8 per share (the market price). In simple terms:

1) Your broker lends you 1000 shares of Ford (from the brokerage’s own inventory)
2) You give him $8,000 as a deposit or collateral ($8 x 1000 shares)
3) You then sell the Ford shares at the market for $8,000
4) The stock price of Ford drops from $8 to $2 in 5 months
5) You buy back the Ford shares, not at $8 but at $2 per share. So you pay $2,000 to buy them back ($2 x 1000 shares)
6) You return the Ford shares back to your broker
7) You pocket the difference of $6,000.

In other words, you made $6,000 from a stock you never owned in the first place. That is a 75% return in 5 months.

As you can see, one of the major benefits of selling short is that you can make money faster in a downward market which I explained in a previous article.

A Major Risk

One of the major risks with selling short is that the stock could go against you and instead of going down, it could go up. Some commentators have said that the risks are infinite. Personally I have never seen a stock go all the way to infinity yet, but that is precisely why we use a stop or a “stop-loss” to protect ourselves in case we are wrong (more on that soon).

Conclusion

The art of making money when stocks fall is not something commonly known or talked about. Again, there could be psychological or political reasons for that, but I believe everyone should learn how to do it.

The biggest risk you can take in a stock market crash is trying to guess that the market has bottomed out or buying stocks just because they are “cheaper”. Instead of fighting the downward trend of that market, you should learn to swim with it and not against it.

In upcoming articles and videos I am going to teach you a very simple but high probability strategy to make money in a downward market. Remember you cannot just guess or gamble on a stock going down. That is as dangerous on gambling on a stock going up.

80 Comments

  1. I find your videos very informational and very motivating.

    There is always a fear factor of putting into play of what you learn. From choosing the right broker to company.

    Keep it up

  2. Thanks Raf – Yes I will post on those things too. Fear is OK. It’s handling it that is they key part.

  3. What’s in it for the guy lending you his Mercedes or indeed his shares? Usually when you lend something you want a cut? Also what are the time frames ie can the lender demand back his shares at any point, or at an agreed point. If he’s lent you his shares and see’s their value tanking surely he’ll want to sell. Excuse my ignorance.

  4. thank you for this expland how to get oney from stock market ..you know i never like to use my money in stock market ..because the people work a get money think is smart.. for me is ”cheats smart” ..is law of economy if you bay everything ….everything in next day you sell 30%down of price you by ..so what’s the point..to sell the car to some one 100000$ and take back with 85ooo ..i dont think is good just arithmetic yes..but anyway you are smart too..and this is good ..thank you.

  5. These are great, keep them coming Alessio

  6. Kumaresa Sereetharan

    Good work Alessio! I realize you are taking it one step at a time. However, I am looking forward for you to get into technical analysis, especially covering the forex markets. Thanks for everything that you have done thus far!

  7. I like very much your video, but there is one thing I don’t understand. How much time can I wait until I buy the stock? Can I sell today and buy 2 years later?

    Regards,

  8. Very understandable and clearly explained.
    But, I don’t see the point in the broker just “lending” you the stocks when he obviously already knows what is the trend of the value and also knows what you’re gonna do, he takes no profit from lending you the stocks. I guess in these cases the broker rather “hires” you the stocks or agree with you to get a part of your benefit, am I right?

  9. gracias! creo que es interesante para gentes como yo que no entiende nada de mercado! ojala tu pudieras ponerlo en espanol , italiano! eres ok!

  10. Thank you for shining the light on this uderserved topic of short selling.

    However, as you said “Some commentators have said that the risks are infinite. Personally I have never seen a stock go all the way to infinity ..” is generally true and “stop losses” can generally protect you, there are outlier situation when even these don’t work like in the infamous Volkswagon short squeeze episode which impoverished a few shorts.

    http://benbittrolff.blogspot.com/2008/10/volkswagen-short-squeeze-hedgies.html
    http://www.reuters.com/article/2008/10/28/us-volkswagen-idUSTRE49R3I920081028
    “Short sellers make VW the world’s priciest firm”

    Perhaps buying some OTM Leap Call options to hedge may be good insurance to protect against such rare but serious occassions?

    A “stop loss” in such concerted squeezes are of course triggered but at much, much higher prices as when a “stop loss” level is crossed, the order becomes a “Market Order” and gets filled at the huge breakout level.

  11. Instead of shorting a stock, how about buying a “short” ETF, like DOG, SH, etc? Thank you.

  12. How do you feel about inverse ETFs, Alessio?

    Liking the blog. Keep up the good work.

  13. For instance if you had stocks in X and its price when down after you bought it now currently your making a loss can u still sell it and buy it later on at a lower price?????????? Or is it benefical to leave the stock as it is and hope for it to come back up.

  14. You rock, man. Very clear & useful. Thanks so much for doing this!

  15. Rule Nr.1:
    DON’T

  16. Sorry for double post.
    What I wanted to say, don’t lend your car to Alessio.

  17. The process is very clearly put well done. Short selling has been in the news quite a bit recently, and it is illegal in France, Italy, Spain and Belgium. Do you think the US and UK markets will go the same way? Explain your answer.
    Good luck with tonight’s interview.

  18. thank you very much!please publish also more videos on your view of the market,if you are given enough time,could you explain why people will be loosing their savings in the next 12 months

  19. Very interesting!

    I believe that knowing what shares are borrowed to sell them in short would be very useful for beginners.

    a) In order to know what shares are expected to fall (If tomorrow morning we would know that a lot of shares of Bank of America are in short, we would foresee that these shares are expected to fall and that this is the forecast of most of the traders)

    b) In order to know when markets have probably reached their bottom and shares are expected to bounce back. (When most of the investors decide not the operate in short any more, probably markets will rise)

    I assume that these idea are not “authomatic” or “infalible”, but could be useful to analyse the trends of the market.

    So, my question is: Is it possible to know, day by day, country by country, how many companies have transactions in short? Is there any web with this kind of information?

    Thank you very much.

  20. Alessio, what in your opinion is the best broker to deal? I’ from the UK btw but I see no reason why I couldn’t trade in the US market as well

    Cheers

  21. John McGuirk (@_LovelyJohn)

    If I as an amateur have information that a company’s share price is likely to fall, surely it would be very hard to sell these shares on the market, as many others would be aware that the shares are going to fall.

    My point/question: how easy is it to sell shares on a market that is likely as aware as I am that such shares are about to drop in value?

    What you talking about here is having vital information (that share prices are about to drop) way ahead of the majority of the people (who believe the prices will rise and therefore be willing to buy) on the market, and it is this information that eludes amateurs like me.

    Am I on target here, in saying all this?

  22. Mr. Rastani, I found the video VERY easy to, understand.

    Thank you as, I did not know what “short” selling was before, wacthning.

  23. Who is the best to trade forex mini accounts?

  24. Thank you for your teaching videos. Good for beginning investors like me.
    I would like to see your tutorial covering the ‘trend’ analysis: how to do and which software to use. Thank you again for your job.

  25. Alessio,

    Please could you clarify how the cash deposit works in your Ford example.

    If I understand correctly, you give your broker $8,000 to borrow the shares and you immediately sell them for $8,000, in effect you have no cash outlay? Therefore, if you buy them at $2,000 and return them to your broker who refunds you $8,000 the $6,000 difference that you pocket is actually a 300 % profit.

  26. John McGuirk, that is known as insider trading and it is technically illegal. Although as markets are based on confidence, I believe it plays a large part in peoples decisions to buy and sell.

    Alessio, so you have borrowed the brokers shares when they are worth 8k. You give them back when they are worth less. When you go to give them back the broker will know they have dropped in value and are no longer worth the 8k you gave them for it before. Does that price still stand because it is collateral and not an actual purchase?

    Cheers, and well done for keeping your cool in the interview!

    Ben.

  27. (Hahaha. That’s funny, the other commenter “don’t lend your car to Alessio” xD )

    Mind if I ask a question? I trade but don’t know exactly which “screens” to have up in the morning. Should I be looking at the Asian markets? And if so, when? Any other concurrent screens that you can recommend while actively trading, or even the night before?

    Thank You!

  28. Great blog and videos Alessio, keep it up!

  29. Hi Alessio, I trade in Argentina, is different from US but the basics are the same. I am about to start trading in US stocks market.

    Thanks for all your comments, videos and everything. Always helps hearing opinions from both sides.

  30. I like your take on trading Alessio. I use a system known as Trend Following. just as the name suggests, when you see a trend, you follow it. Most of the comments from people on here seem to focus a lot on the fundamentals of a company/industry and using it with technical analysis. Knowing the fundamentals is nice, but at the end of the day its all about profiting. Price is all that data you need. Nothing else matters. Using fundamental analysis is trying to predict the future and no one has the ability to do that. with Trend Following it doesn’t matter which market you are trading. Once you establish a trend following system, you “ignore it like brick wall.” don’t pay attention to the “talking heads” on TV who always have a story for every small thing that happens in the markets. if you trade the markets on news information you will lose! it is that simple!

    for more information on trend following, google a man name Michael Covel. He is written quite a few books on Trend Following. Trend Following works.

    Again I say, the price data of a stock, commodity, metal or whatever you want to trade is all you need. Everything else is just noise!!

  31. Hi, Thanks a lot for the info you are posting.

    I would like to ask you about the banks in Europe, particulary in Spain. What is your opinion about Santander or BBVA? They have lost a lot of value already, and they seem too big to fall, it is a good moment to buy or is better to wait?
    Regards from Spain!

  32. Alessio,

    I think what you are doing is great and your willingness to help people who don’t know much other than letting financial planners handle their money is wonderful, however I believe many who are flocking to your website are trading noobs and don’t realize that what you are talking about when shorting a stock is also known as leveraged trading and they probably don’t realize how badly a trade can go against them when using leverage. Maybe basic options (with limited downside potential) would be a good subject to discuss as well. And never forget DYODD.

  33. I would agree with you Mickey. I am considering talking about the major risks and options too. I am glad you brought it to my attention. Take care and happy trading.

  34. How do you know when you buy sctocks? on the high point?

  35. Alessio,

    I assume the broker gives you the $8000 deposit back when you return the shares to him, but what’s in it for him is there a commission? Also, when you do this how long have you got before you have to buy the shares back?

  36. Thank you for sharing 🙂

  37. Thanks Alesso

    I look like you! Hopefully I can trade like you too now using your awesome videos!

    Cheers

    Masum

  38. Hello Alessio!
    I just started trading ETF’s online and I have a question, actually many, but I will ask one for now. So far I have made $1000 in just two trades(buy lower, sell higher) on FAZ, which has been pretty consistent since August. Now it has jumped up a good $10 or more and I am wondering what is the forecast(as much as you would estimate) now with FAZ and a new one RUSS that I have also been studying the last two weeks? Any info would be sooo helpful!

  39. Alessio

    Excellent video on short selling. You made it so simple to understand the concept. As everyone else I have the same question on why would broker lend you stock and what’s in it for him? Also what happens when prices go up rather than down, you have to buy at higher price?

    Are you going to show us some technical analysis singals to find out which stock to short?

    Thanks

  40. Excellent video! But can you point me to free analysis tools? As you said, need to do some homework and it would be nice to have some tools and websites for information analysis. Many thanks.

  41. Alessio,

    Good basic explanation. For UK based traders a spread bet would work equally as well.

  42. Hi,

    I tought you could only buy and sell on the market but not land stocks. Is this a service that all bank offers or only brokers? If I choose to start investing, how can I make clear that I want to land stocks and buy directly?

    Thanks

  43. Cool man, great videos, keep em coming!!

  44. BBC and ITV. You are doing great. Lookin’ forward to some future tv appearances. Keep them jaws droppin’!

  45. Behind the expensive suits and the talking heads and the constant reassurances there is a simple truth. The Stock Market is and has always been a suckers game!

    Consider the following:

    1. The S&P 500 is a big barrel of money. When the money gets to a certain level, the Psychopaths drain it off. In order to get it to a certain level, you have to buy the B.S. and turn your life savings over to them.

    2. Only a few insiders actually buy and sell stocks. These institutional investors and market makers bring the market down by selling stock into the market.

    3. The S&P 500 represents 75 cents of every dollar invested in the stock market. That means 500 company stocks to sell when they want the market to crash. Not that hard to accomplish when you think about it.

    4. The other branch of the Satanic Psychopaths catch all that falling money buy buying Put Options against the S&P. AS the S&P goes down, they are capturing all of that lost wealth.

    5. My Clients have made anywhere from 20-50% returns over the last week by also shorting the stock market. One client made $2400 profit from a $3500 investment. Can your stock broker do that? If so, why aren’t they doing it? Instead, they are standing idly by while you lose money!

  46. i am already on your trading alert system.
    thank you!
    i looked you up after some press, and what you had to say makes sense. Since i knew someone who did this type of trading 10 yrs ago, i was intrigued.
    He however understood it very well and made a lot of money.
    Unfortunately, he needed more money to get back in because, as he said, he did not follow his own rules and thinking he could make more …..lost everything!
    He lost “everything” several times. Not learning to just stick to his own rules of when to ‘get out’.
    I am hoping i can learn from you.

  47. Sorry, you were asking about the video!
    it was very clear, easy to follow and i hope it is all like that!
    thanks again. it is actually quite exciting!

  48. Thanks for the video! I would like a video of you talking about options! take care!

  49. Great info Alessio, Kudos from Sacramento, CA!
    Does the broker get pissed at you for the loss of value to his stock? Can he keep your deposit since his stokc lost value while it was in your custody?

  50. Hi Frugal. No not at all. After all brokers know how selling short works. No he cannot keep your deposit because the stock value has gone down.

  51. Thanks Allan – will keep you updated on that

  52. French bank Societe Generale offer a variety of structured products you can use to take short positions on just about anything, from individual commodities to world indices. lots of useful learning info on there too. Be aware that SG are apparently heavily exposed to Greece so don’t go piling your life savings in there!

  53. Very good presentation; principle clearly illustrated.

  54. Found your video on shorting very helpful. I understand the basic principles of shorting. But your analogy of the car followed up with your example with F helps me visualize the ideas.

    My question: Is there a time limit to which a broker will lend the stocks? For ex: can I call my broker (Schwab) and ask them to loan me 100 shares of SBUX for $4180 deposit. How long do I have before I have to buy them back and return to Schwab? 3 months? 6 months? until the market tanks again? And how about liquidity? I assume this much harder with small caps?

    Loved your BBC interview. You’d think your comments wouldn’t shock anyone. But I work for a buy side firm and you should have seen when I tried to tell some co workers about GS’s influence ion the global economy (one even WORKED for GS!) about a year ago. And great interview on Infowars despite all of Alex’s ranting and interruptions ;o)

  55. Very crisp and clear video! Liked the example of a car. Looking forward for more videos of knowledge.

  56. can you do this with an online broker company? i am changing from a traditional broker to online because of the high commission rates. what do you recommend using for trading stocks?

  57. Very well explained… The mistake i keep making is not having an “exit strategy”.

  58. a good video simple and informative, u mentioned somthing about the put options in down trend senario am sure u can squeez gd short video about profiting from “put” option in downmarket.

    great tnx.

  59. A reminder that SP500 / DOW weekly indicators gave a mild bullish warning last week.

    When confirmed, it suggests we may see a significant equity rally this year.

    Importantly, monthly charts remain bearish and this will not change.

  60. I have always thought that these kind of businesses are very badly explained. This is better but I still dont get some parts.
    HOW do you in practice “borrow” the shares? On my online broker I dont see any obvious option for this. And as several have already mentioned, what does it cost to borrow the shares. I am pretty sure I cant borrow them for free.

  61. Pingback: Wall Street Protests | Why The Financial | Leadingtrader.com

  62. i totally agree n appreciate ur honesty in tradin d mkts n be a brave front against d sachs of d world.
    bt its easier said den done. hve u ever made a fortune in shortin ne stocks in 2008? even u knw d answer!!
    also, if by ne chance if u hve made some, y cnt u post ur tradin ledger summary showing trades done!!
    also, ur very vocal abt ppl getting educated in stock mkt. why dont u educate us wid ur trading sys? tell us how u short/buy/sell stocks following which logic. gives us d systems wid indicators n parameters fr each. let us try it @ our end n see if ur trading setup works or u talk only in AIR??!!

  63. Rohit – I like your comment. “Walk the walk”, not just “talk the talk”. You are absolutely right of course. Well, rest assured I will publish all of what you say. As for my own trading, I do very well. I would not be pursuing it for 6 years if it was not working out for me. I would not waste my time. By the way 2008 was a fabulous year for me. How about you?

  64. when we are going to have a major global financial collapse: will your money (your put ETFs) be safe at a broker like TradeStation (owned by japanese Monex) ?

  65. Cool. I nice the Mercedes example. Keeping it simple so anyone is able to understand. Nice post!

  66. m nt experienced n full time trader as ur! m very new to trading – roughly last 2 years of serious but part time trading. building a trading setup/logic wid various parameters has nw becum my priority!
    well m frm india n luckily or unluckily i started my naive trading in jan 2008 n lost quite a chunk which i recovered slowly n steadily till october 2010 by buildin my own trading setup. nw my a/c is in positive. bt still think i cn improve my setup quite a bit.
    hope u wd b a gr8 help thru ur posts where u cn discuss ur setup/system in details.

  67. Hold on.. you expect me to believe that a broker who lent you 1000 shares that were worth way more than 2$ is going to take them back and give you back your deposit? Someone has to show me that.

    You deposit 8000 and then get 8000 back, that is zero. You buy with 2000 that – 2000. Now if the broker gives my the 8000 back when I return the shares, we are in business. Think about it.

  68. Alesio, thanks for the great examples. In the real world of a broker like Fidelity, how do you “borrow” stock from them??I don’t see any choice in my trading options that resembles this.

  69. Alessio,

    Many thanks for your insightful commentary. Here in Australia, the government has prohibited short-selling on occasion to try to stop larger ‘players’ (like the hedge funds) from driving down the stock price of certain companies to absurdly cheap levels, then loading up at basement prices to catch the inevitable rise. Do you have a view on that practice?

    Regards

  70. Thanks Alessio. Sometimes I wonder at the difference in how my mind works to this whole new world; so now it seems, that this concept of leverage, just means ‘borrowing’ and although I knew that conceptually, I did not BELIEVE a market maker would want to LEND (Currencies) to some stranger they don’t know from Adam.

    The really tough part I have been grappling with over the past couple of days is getting to grips with the process of how this works. Your video goes some way to explain that, however, if one is trying to work out what one can feasibly invest, when cash-strapped, there are some steps to be taken before that initial outlay investment.

    I.e.PRICE PER POINT and what this means for one’s deposit. Do you have an idiot’s guide to which comes first, setting one’s daily pip target and / or setting one’s pip target according to ones available margin. EG If I put £50.00 as my initial account deposit and
    1. I am looking at currencies with the lowest spread (eg 4 pips) to keep down cost of my trade AND
    2. I should not risk >20% of my account (i.e. </= £10.00),
    3. NOR expose any more than 5% (£2.50) of this account, then please can you verify what the next step in the calculation process is and clarify my confusion here?

    EG Scenario: I have chosen a low spread pair: EUR/USD (let's say bid price = 1.3506 / ask price = 1.3509 at time of order). I want to take a bearish position. (My stop is set automatically via my market seller anyway, so I cannot risk too much anyway, but…) What is my stop position given collateral constraints? (Ideally I want to start at least achieving at least a ten pip target – ideally 20 pips per day and turn my £50.00 into £500.00 ASAP WHILST minimising risk! : D )

    What is the next step in the calculation… I never was good at maths logic, but I am determined to break out beyond my own resistance levels to crack this simple equation! lol

    Loving your beginner's tutorial videos. Thanks for taking the time to spell the basics out for us newbies. Dee

  71. Hi Denise – thanks for your question. Hopefully this answer will get to you. The first thing I would say is that in the example you gave me, £50 as a starter capital, is not a good idea. The major challenge with a lot of traders seems to be that they are under-capitalised from the start. Therefore I would not apply the 5% risk management to £50 as it would be extremely difficult to trade. What I would do is, if £50 is a starter, is split the £50 into two trades putting £25 at risk. If you are doing spreadbetting, you can do 50pence per point, and risk 50 points (stoploss) then you will lose £25 on one trade. Personally, this is still not a good idea. The best thing to do is start with a capital of £2000 at least. This will give far more flexibility. One of the major reasons why traders lose is that their stops are too tight and they get stopped out very quickly. Hope this helps. Alessio

  72. Very illustrative, but please include the cost of borrowing the stock and also the interest gained from the short rebate to give a true estimation of the profit. But very informative, I enjoyed it

  73. Hi there Alessio! Great teaching session! Simple and to the point!

  74. Hi Alessio! I find your videos on Short Selling interesting. I’m a novice at all this & I don’t understand why my broker would be so benevolent as to just lend me stock to make money from which he might just have on hand. Why doesn’t he make the money?

  75. Hi John. The practice of lending shares to clients is quite common among US brokerages – I recommend you do further reading about “margin” and “margin accounts”. Also, your broker does not lend them to you without a collateral which he holds as deposit until the shares are returned. This practice keeps the markets liquid and active (besides other advantages).

  76. suzanne wallis-boden

    Thanks for a great video …..keep up the good work

  77. Thank you Suzanne for the comment on my blog post. I am glad the video helped. Alessio

  78. Great video and worth to be appreciated. Thanks for sharing such useful article.

  79. Denise. What you need to do is find a broker that lets you trade microlots..

    In times of volatility, the forex market can move 150 to 200 pips a day.

    If you have a microlot, that equates to 9 to 12 GBP. YOu should never risk more than 5percent of your bank. 5percent = 1/20th

    Therefore your absolute minimum starting capital should be 240 pounds.

    As you get better at trading, and begin to be p[rofitable, just increase your stakes to 5 percent of your bank

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