This article isn't going to be for everyone; let me just say that right off the bat. There's going to be a group of experienced traders that will take a look at this article and have a laugh. "I've known that forever!" They'll laugh and opine to me, "Tell me something I don't know!"
This article is not for you, Mr. Moderately-Informed-to-Somewhat-Savvy trader. This article is for people who are getting started on investing and are looking to learn a couple things that they don't necessarily teach you when you first start investing. Two little things that everyone eventually learns, presented here with as little conjecture and as simply as possible.
You must realize at first, the uninformed are looked at, by Wall Street, as sheep. The people who are blindly putting money into their 401k plans, saving diligently, and investing by buying and holding are viewed as the sheep. This is why, when the country finds itself in a financial panic, these are the people whose accounts get wiped out while the rich get richer.
"How the hell can that happen?", people ask themselves. Government bailouts are for major companies while the common investor's 401k simply disintegrates and eventually winds up going toward some billionaire's landscaping bill?
However, there comes a point in everyone's financial education where they can start to pull back the curtain a bit on how the experienced traders on Wall Street operate. The quicker you get to this point of perspective, the more quickly you are likely to place trades like a shark, instead of getting eaten by one.
In between articles about separate equities and trades, I like to try and give as much insight "behind the curtain" as possible. I've heard too many stories from great people that I've known and worked with who only know how to invest as "buy & hold, wait for the market to go up". Unfortunately, these are the same people that wind up getting completely wiped out.
You Can, and Experienced Traders Do, Make TONS of Money When the Market Crashes
Buying a stock and holding it, in the hopes that the price is going to go up is called going "long". Selling the stock and hoping to buy it back at a lower price is called going "short". Because you don't own the stock to begin with, you borrow it from your broker. Then, when you buy it back (or "cover") you pay your broker back and pocket the difference in the price drop.
People will tell you that shorting is complicated and you'll never figure it out, but for the most part, that's all there is to it. People will also tell you this about options, and that's not true either (but it's a whole other article in and of its own).
So, the people who make money when the market crashes aren't just people who are shorting stock, but people who are positioned short; meaning, they want prices to go down because they're positioned through some instrument that benefits from this. There are now, tons of easy ways to position yourself short, thanks to ETFs and options.
All you have to do is read any of the articles where I'm short a stock to realize that going short something may not make you the most popular person in the world, but it's a strategy that has to be implemented if you want to continue to make money in the market at all times.
If you can't realize that the stock market is based on a very Darwinian sense of survival based on numbers at the end of the day, you're not going to make a good trader. Good traders realize that there's simply some companies out there that are not going to make it, and they bet accordingly. 9 out of 10 companies are not going to be the next Apple (AAPL), GE (GE), or Coca-Cola (KO). So, when you find a company that appears to have no hope left (like JCPenny (JCP), Radio Shack (RSH), or Sears Holdings (SHLD), in my opinion), you need to position yourself accordingly.
Also, bull markets can't last forever. As I stated in a previous article, "3 Moves to Make on the Verge of Market Panic":
Folks, no bull market lasts forever, and to me, the signs have never been clearer that the floor below us is about to give out. To think we can continue to move upwards the way that we have forever, especially in the wake of how we're diluting our currency, is simply foolish.
In addition, volatility tends to skyrocket during times of financial unease. Like everything else, there are now derivatives and ETFs that you can buy to go long volatility.
10 Ways to Position Yourself Short For a Bear Market:
- Buy puts against long equity positions you want to hold
- Write calls against long equity positions you want to hold
- Go long Gold (GLD) & Silver (SLV), which both traditionally rise during bear markets
- Sell short a competitor to your long positions as a sector hedge [i.e. If you're long Apple (AAPL), short Intel (INTC)]
- Buy inverse index ETFs like DOG, DXD, QID
- Buy puts against or short long ETFs like SPY
- Go long volatility ETFs, like VXX, as the VIX spikes during bear markets.
- Buy ETP's that track the VIX, like UVXY and CVOL
- Buy VIX call options
- Buy call options for or VXV
Analysts and Media All Have a Stake in the Game and Make Money Off of Common Investors
This was something that I started to touch on in a previous article. In "My Definitive 17 Cardinal Rules for Investing Success", I introduced this topic by citing the now famous Jim Cramer/Jon Stewart exchange on The Daily Show:
As much as I hate (read: love) to bash Jim Cramer in two successive articles, he's the pinnacle example of this rule. Much of the public was absolutely flattened when they watched his interview a couple of years back on the Daily Show. In this interview, Jon Stewart played back for Cramer a YouTube video of himself openly admitting to making up and disseminating rumors about about companies when his hedge fund was short them. This was the public's first glance into the dirty work that goes on behind the scenes at hedge funds; if they knew the down and dirty details, jaws would drop all the way to the ground.
The lesson I hoped the public learned from this is that 95% of the people feeding you advice; whether it's here on Seeking Alpha, on CNBC, or in the Wall Street Journal all have agendas and positions that they're trying to make money on. Believing these people disclose these positions all the time is laughable. Take everything, including what I write, as a sales pitch. Go in as a skeptic and question motives. Again, finance is a lesson in Cutthroat 101.
Everybody knows that the media can move the markets. Articles on blogs can move illiquid stocks large percentages in mere days. People familiar with the "pump & dump" game (and the "short & distort" game), usually with OTC stocks, can attest to this first hand.
What goes on with CNBC TV, Bloomberg and other outlets can simply be a macrocosm of the old "pump & dump" strategy sometimes.
We've all seen Cramer get on CNBC and start screaming about a stock during the middle of the trading day, and next thing you know, it's rallying. Conversely, we've seen analysts or hedge fund heads be bearish on stocks and have witnessed their collapse during the middle of the trading day as well. If you think these people (directly or indirectly) are not positioned in certain fashions before doing this, you're way too naive to be an effective investor.
Another perfect example comes from Goldman Sach's recent downgrade of gold. On the heels of the downgrade, I respectfully suggested that Goldman may have been doing so to cover a short position. Low and behold, just days later, we find out that was exactly the truth. I wrote:
Goldman Sachs on Tuesday reversed its high-profile call to short gold, which it made two weeks ago, just before the metal sunk into bear market territory. The firm's commodities research team said the decline in gold was more rapid than it expected, and it exited the trade with a potential gain of 10.4 percent, below its original target price of $1,450.
Interesting. Goldman was short gold before issuing a "world is going to end" style downgrade on gold and then covered their entire short after the market and the common folk sold off to bring gold down about 15%? Duly noted. I'm not saying it's market manipulation, rather just a series of coincidences. Yeah, let's call it that. For our visual learners, here's a picture version of all that pesky text you might not want to read through:
How you can position yourself:
This is a question of simply betting with the house instead of betting with the player. After recommending buying Gold on the downgrade, I reminded that GS is now long, too, having covered their short and that they should continue to ride the uptrend with Goldman. Remember, the institutions make money both ways: up and down.
I always try to remember to consider the opposite of what the public is doing. The sharks and analysts make money because they're buying into the public selling or selling into the public buying. As I've often stated: It's important to not blindly just do the opposite of what the public's doing; the public creates important trends that need to be respected and noticed. In the world of sports betting, the benefit is usually a couple extra points on a line; in finance, the benefit is usually a cheaper share price to buy at or a higher share price to sell at. Keeping your emotions in check is vital, as I'll discuss later. These strategies play off the emotional instability of the common investor.
Keeping yourself in this mindset of doing the opposite of the public is how big money makes money, and how you can, too. The sooner you start to think like one of the sharks, the less chance you have of being eaten alive.