How to make money during a market crash?

How to make money in a market crash?

by Rajeev Pathak

 

   NIFTY 27.01.2023 (Courtesy NSE)

    In any business, one can sell something that he owns. In most cases, people buy first and sell later. The ultimate goal is to make a profit. It is endeavored to buy at a low price and sell when prices go up.

Short Selling:

    In the case of Short Selling also, the same principle is followed. Short Sellers also endeavor to buy low and sell high. The only difference is, in Short Selling, a trader sells first and buys it later.

    In a bearish market or on a day when markets crash, people sell first and buy later when rates are declined. Even on normal days, a trader short sells when he expects that prices of a particular stock or a commodity or INDEX will go down in the near future. This near future may be a few seconds, a few minutes, hours, or even a few days or a few months. The Short Seller sells it first in anticipation that prices will go down. If markets move in his desired direction, he buys the stock or INDEX at a lower price and takes profit home.

    Let us understand this with an example. On 25^th January 2023, BSE SENSEX closed at 60,205. On that day markets closed lower due to the news of the Hindenburg Report about the Adani Group companies. The NIFTY and Bank NIFTY INDEX also closed with substantial losses that day.

    The next day on 26^th January 2023 markets were closed on account of Republic Day in India.

How money is made during a market crash?

    On 27^th January the Hindenburg Report was known to every investor. The SENSEX opened at 60,166 and the same level remained the highest level for the rest of day. It went down to 58,974. During the end of the session, SENSEX recovered and finally closed at 59,331, ie.874 points down vis-s-vis the previous trading session.

    So what we observe from the above. If a Short Trader has sold the SENSEX or NIFTY or Bank NIFTY at the opening of the market and buys at a lower price during the day, he could have made a substantial profit by the end of the session.

    In the same way, one can short-sell any of the INDEX or stocks. For example, on 27^th January itself, Adani Enterprise was the worst sufferer in NIFTY 50 INDEX, it closed at 18.52% down from its previous closing price.

    Likewise in SENSEX 30 stocks, the banking major State Bank of India (SBI) was the worst hit, it closed 5.06% down from its previous close.

    Anyone who had short-sell Adani Enterprise or SBI would have made a handsome profit. How much, depends upon his entry and exit levels.

    The Short Selling facility is currently available for Derivative segments of Commodity, Currency, and Interest Rates.  

What are the Risks in Short Selling?

    It’s not the case that a short seller always makes the money. If the markets do not move in the desired direction, he could incur losses. Many times, it happens that markets open with a gap down and then recover substantially. If the seller is not able to square off his position at the right time, he is bound to suffer losses.

How to Short Sell?   

    Short Selling has been in place for ages even when markets were not regulated and there were no computers. But now there is a system in place and markets are regulated. With the invention of technology and the internet, Short Selling has also become systematic and specific products are there, in place.

    In this post, we endeavor to  explain how to Short Sell with specific reference to equity markets:

Margin Trading in Cash segment:

           Almost all brokers allow margin trading. The Short Seller sells the stock by paying the applicable margin to his broker and squares off his position when he gets his price or the scheduled cut-off time for squaring off the position. Indirectly, he borrows the stock to sell by paying a margin. This margin trading facility is available for intra-day trades. Of late, a few brokers, have permitted short selling on a positional basis under MTF (Margin Trade Funding). In this segment, one can sell/buy any number of stocks depending upon his risk profile and available margin.       

     Futures-Sell:

    The Traders who have enough risk appetite trade in Futures. Futures are the type of Derivatives. In the Derivative segment, one can trade only in lots, pre-decided by the Stock Exchanges. For example, the current lot size for NIFTY is 50 and for the Bank, NIFTY is 25 units. For SBI, the lot size is of 1500 shares while for Reliance Industries, it is 250. Traders should know that trading in Futures requires a big money in the form of an initial margin, Mark to Market margin (MTM), and Peak Margins, and the chances of losing the money are very high.

           Put Option-Buy: 

        Another way, to short sell, is to buy a Put Option of that particular INDEX or stock. The lot size is the same as in Futures. The attractive feature of this product is that the loss is limited to the extent of the margin paid at the time of buying the Put Option. However, the scope for profit is unlimited. 

        But there are two major risks with Put Buying. One, the market regulator and Stock Exchanges have implemented physical delivery of stocks if the trade is In-the-Money (ITM). One should understand this aspect and close his position timely if he is not able to take or deliver the traded stock. 

        The second major risk is that with the passing of every moment, day or week, the value of your Put decreases substantially. People compare Option Buy with an ice cream that starts melting the moment you buy it. If the market goes against your plan, the value of your Put may be zero on the day of expiry.

         Call Option-Sell:     

        One can also Sell a Call Option to take a short position. In this case, the risk is as high as in the case of stock futures. The margin requirement is also very high.

     Conclusion:

    The above information is shared for the purpose of learning only. We do not encourage you to take short positions without proper learning as the risk in security markets is Very High.

    As your hard-earned money and mental peace are at stake, please do not jump to trade in the Futures and Options segment. Please learn more and consult an expert before taking any trade.

    We would love to have your feedback in the comments column. Your suggestions are also welcome for the new topics you would like to learn through this blog safal-nivesh. 

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