Profiting from the Bear
Profiting from the Bear
Like many things in life, the stock market has its own ups and downs. The stock market has been known to expand and grow as well as go down and decrease. This is one of the reasons why the Dow Jones Industrial Average was used. Historically, the ups and downs of different stock markets all over the world have been regular, almost forming a trend or a pattern with varying factors that contribute to the stock market behavior. One can even say that the ups and downs of the stock market is cyclical and at a period of time, it is bound to go up or down as in previous times. Because of the cyclic and even repetitive nature of the stock market behavior, the participants in the stock market gave a name to these up or down stock market phenomena. The stock market has been said to be bullish if its stock prices are continually increasing and expanding whereas the stock market is said to be bearish if the prices of stocks are continually decreasing. In previous articles we learned that one of the ways to earn from stocks is through capital gains. But did you know that one could earn capital gains even when the stock market is bearish and the stock prices are decreasing? This practice has been called shorting the stocks. How can one profit from a decreasing stock market, you ask. Here’s how.
One is said to have a long position when one owns stocks and buys and sells the stocks that he owns. But one can also have a short position where one sells and then buys the stock that he does not own. Yes, you read it right, you can profit from stocks that you don’t own. It has been a custom in the stock market where an investor can ‘borrow’ stocks from a stockbroker, even without the stockowner’s consent or knowledge. In shorting stocks, the stock borrower borrows the shares of stock of another and sells these stocks at the current stock price. The expectation of the stock borrower is that the stock price would go down, thereby when he buys the stocks that he originally sold, he would be buying them at a cheaper price, therefore earning from the bearish market or decreasing stock price.
To understand profiting from the bear market, an illustration is in order. Let us assume that investor I has 100 shares of stock X currently valued at $40 each. Stock borrower or investor SB wants to profit from the bearish market so he borrows the 100 shares of stock X and sells them at $40 each. After a few months, as expected by investor SB, the prices of stock X decreased to only $35 each. Investor SB then buys the same 100 shares of stock X at $35 each, earning him the sum of $500 in profits.
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