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Chapter 7




Peter Read, CEO and Founder of Pelican
Apr 18, 2018


How do I profit when markets fall?



To profit when a market falls requires you to open a “short” trade. i.e. you ‘sell’ something now in the hope of buying it back later on.

Yet, how on earth do I ‘sell’ or ‘go short’ of something I don’t actually own?! This concept is one of the hardest for novice traders to grasp. Yet, in times of volatility, this functionality to ‘go short’ can bring rewards, as one can profit from market falls.

Imagine you are an artist and you agree to sell a painting for £1000 today, but will take one week to complete. You calculate that your time, effort and materials cost £500. Your profit will be £500 on this work of art. You have ‘sold’ something you don’t yet own, in the hope of ‘buying’ it back, or in this case, ‘producing’ the asset at a lower price in the future. You sold ‘higher’ than you ‘bought it back’ at.

The profit is exactly the same as if you have already produced the painting, which cost £500 in time, effort and materials. A collector comes into the artist’s studio and buys the painting for £1000. You made a £500 profit.




In the first example, you ‘sold’ at £1,000 and ‘bought’ back at £500. £500 profit.

In the second example, you ‘bought’ at £500 and ‘sold’ at £1000. £500 profit.

Eg If you think the price of gold is set to drop, you would ‘sell’ or ‘go short’ today. If the market does indeed fall, you would ‘buy’ back at a lower price. This is exactly the same principle as the first example. Sell now at a higher price and hopefully buy it back at a lower price later on. Remember that if the price actually went higher, then you would lose an increasing amount of money for every cent the price of a barrel of oil moved.

If you think a particular share is really overvalued, then you can ‘sell’ or ‘go short’ today in the hope of ‘buying’ it back at a lower price in the future. Pelican’s most popular ‘short’ trade at the moment is the US electric car business, Tesla. Traders believe it is overpriced and thus ‘sell’ the shares that they don’t own. If the price falls, they profit. But remember that if the price rises, then the trader would lose a multiple of his or her stake.



 



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