Profit from a Stock Market Crash

by Wes Bridel on August 9, 2010

in Stewardship

Do you know how to profit from a stock market crash?  We’ve been discussing asset management in a crazy economy.  If you believe the market is going to become either more chaotic (particularly to the downside) or more sanguine, trading volatility can be an excellent way to speculate on this in the short term.  If you believe a stock market crash is coming (as we do), we’ll explain a how to profit from this.

This Index measures the price of options on the stock market.  When the market is calm, volatility is low.  When there is a stock market crash, volatility is high.

If you take a position long or short volatility with the idea that you would hold it forever, you would not get anywhere.  It would simply oscillate higher and lower the entire time you owned it.

However, if you have strong belief that the market will become either more or less volatile, you can speculate on this belief by trading either long or short this index.  If you believe the market is eerily mellow at the moment and that there is sure to be more chaos coming in the relatively near term, you can trade on this idea and as volatility enters the market, the index will rise and you will profit from its rise.

If you believe the market is extremely volatile and is sure to settle down a bit, you can trade on this idea by shorting volatility and you will profit as volatility reduces and the index lowers.

The difficult thing is knowing when to buy and sell.  At what point with the volatility subside and this index drop back down?  Looking back at past prices, it is easy to say with hindsight when the best times to sell are, but impossible to know for sure in the moment.

One method ensuring a gain, but leaving room to let profits run would be to choose a point at which you plan to take some profits and deciding ahead of time that you will sell half, or a third of your position if a certain point is reached.

You could then put in a limit order to sell half of your position at when a certain level is reached.  An example would be when the price doubles from when you bought (assuming you’ve bought sufficiently low).  If that happens, you will ensure that you have all of your principal back and then still have half of your original position to see how high it might go.  You might decide to sell all of it or another portion at different levels as it goes higher, or you may decide to watch it and make that decision at the time.

When it seems like the point of ultimate fear is reached, you should sell the position.  It will not go up forever and you want to capture the gains before it comes crashing back down.  This can be a simple way to earn triple digit profits in a fairly short amount of time.  Of course, you never know how the market will react going forward so don’t be greedy and take some easy profits along the way to ensure that you do actually capture them.

We believe that there will be tremendous volatility in the coming years, so if you agree and can buy when volatility is low and wait until the next bout of volatility occurs, you can profit handsomely on these short term trades.

If you have any thoughts or questions on this or other topics, please let us know.  We’ll look at factors to consider when investing in gold and silver companies next.

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