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How to make money in a falling market?

Well, what if you could make money irrespective of the stock market direction or phase?Whether it falls or rises or stays in a range, there is a way to make money if you know the right way. When you buy stocks, the only thing you can do for making a profit is wait for the prices to go up. What happens during a time when the economy is going through a rough patch and hence the markets are underperforming. Consolidations in stock markets are painful and they drive out many participants.

Making money in falling markets is conceptually as simple as selling your shares at a higher price and hoping for the market to fall. When you feel the market has fallen enough, you can simply buy back your shares for a lower price. The difference between your selling price and buying price becomes your profit. Now, you may wonder what if I do not already have shares to sell? Well, in that case, you can make use of Futures & Options.

Futures: When you are expecting the price of a security to fall, all you need to do in futures is take a SHORT position. What is a SHORT position? If you feel, the price of a stock will fall from 100 to 90, you take a short position in the stock without actually holding the stock. When the target price of 90 is achieved, you simply buy that stock back. In Futures terminology, we have something called as a lot. Generally, the size of a lot in Indian market is 5lacs. What this means is if the price of the stock is quoting at Rs. 100, you will short approximately 5000 shares. When the price falls by 10 rupees, you make 10 x 5000 = 50,000 rupees. This concept of buying/selling more than the money you have is called as leverage.

Now, you may wonder how is that possible? Well, this is possible by way of putting margin money. When you are betting for the stock price to fall, you have to deposit a margin with the stock broker. Generally, the margin in Indian markets is 12-15% of the total lot size. So, for a Rs. 5 lacs lot, you have to deposit approximately 60000 rupees as margin. If the stock price starts moving against your position, the loss is adjusted from the margin money. In our case, if the stock price moves above Rs. 112, you have to deposit more money(Different brokers have different criteria for margin money calls).

"Leverage is a double edged sword"

Options: In the same example as above, if you believe the stock price will fall to 90, you can take positions in options. Options gives you a margin of safety to play. There are basically 2 types of options: Call option and Put option. If you believe price will fall, you can buy a put option or short a call option. Vice versa, if you expect price to rise, you will buy a call or short a put option. When you buy an option, you pay an amount to the counter party who sold you the option. This amount is called as the options premium. You need to pay this premium for the risk the other party is bearing. This is similar to buying an insurance policy. The insurance company is selling you an option of getting the sum assured in case of any untowardly incident. If you are lucky and there is no casualty, the insurance company benefits by pocketing the premium you paid them.

What is the difference between buying an option and shorting an option? In case you buy an option, your profit potential is unlimited, and your loss will also be limited to the extent of total price of the option. In case of option shorting, your profit is limited to the extent of the options price, but your loss could be unlimited.

While this looks very easy to make money, it is difficult to execute. Leverage, if not understood properly can be devastating for your portfolio. If you are interested to learn more about this subject, you may visit our learning page here.

Happy trading!

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