The Best Ways to Profit from a Stock Market Crash

A Complete Survival Guide for Bear Markets

In the long run markets go up. That’s a verified fact. But downturns and crashes are not uncommon.

Take the 2008 or 2020 tumbles, spectacular, right?

So you’re surely asking yourself: what are the Best Ways to Profit from a Stock Market Crash ?

Well, there are huge opportunities to trade when markets come crashing down.

This Guide is going to give you a number of options to profit from bear markets.

But first, a few things you need to know.

What defines a bear market, or a market crash?

Usually, a bear market condition is declared when a particular index (say the S&P 500) experiences a decline of 20% or more during a reasonably prolonged period, 2 months or more.

So, before you start considering the strategies below, you need to make sure that you’ll be operating in the actual conditions of a bear market.

To do that, start by picking a broad market index (S&P500 or Nasdaq in the US, FTSE100 in the UK, DAX in Germany,…) and pull up a chart of that index in your favorite platform (I use TradingView).

Now watch the chart carefully.

If the candles are making lower highs and lower lows on a consistent basis over at least a two months period, the chances you’re in a confirmed bear market.

Why is trading bear markets psychologically difficult?

First of all, playing against the trend has always been difficult. Following the dominant trend is much easier.

The loneliness of the short trader is well-known, this is one of the greatest difficulties you’ll face.

Another one is the fear of unlimited losses. When you’re long, if the stock goes down the most you’ll lose is 100% of your position. But if you’re short and the stock keeps going up, there’s no limit to your losses… Well theoretically, because in real life your broker will have margin calls and close your position.

Don’t try to pick tops and bottoms

We all think we can be smart and pick perfect market tops and bottoms. But actually very few people manage to do that.

And you know what ? It’s totally useless.

There are dozens of ways to profit from a market crash, there’s really no need to waste precious capital on bottom picking.

And picking a bottom is always contrarian, it means trading against the trend. Taking a bet that market direction will reverse. More often than not, you’ll be wrong.

So better go with the flow, and trade with the prevailing sentiment, go short.

So, how can you win in Bear Markets?

There are many different ways you can win in bear markets. The first thing you need to do, is make sure you’re at ease with trading mechanics (position sizing, risk management, ….).

If you’re just starting and want to learn trading, read my Complete Guide here.

Then you have to make sure you’re psychologically ready to go short.

What does shorting mean and how do you do it?

Usually, you will buy an asset for a profit hoping its price will rise (called going long).

But you could also sell it and buy it back hoping its price will drop (going short).

Going short is a counter intuitive way of trading and cannot be done on all assets.

It’s also extremely regulated, because losses can be unlimited. So speculating on the decline of an asset is quite an advanced strategy, and should only be undertaken by experienced traders.

Some traders are making a killing out of it. Check out Alex Temiz on Twitter, he’s a fantastic short trader.

Ok so now let’s get down to the five ways you can profit from bear Markets.

Five Ways to Trade Bear Markets or Market crashes

  1. Short the indexes
  2. Short weak or vulnerable stocks
  3. Take leveraged shorts with futures or CFDs
  4. Buy inverted ETFs
  5. Trade VIX futures to profit from volatility

1. Short the indexes

Choosing an index is a way to speculate on the broader market. You can short the Dow or the S&P 500, the German DAX or the UK Footsie (FTSE). If you think the overall sentiment is negative, there are three ways you can short the indexes:

  • Selling short an index ETF, such as the NYSEARCA: SPY for example. If you don’t know what an ETF is, check this article.
  • Buying PUT options on the index. Read this article for further information on Index options, or this Strategy to anticipate a market correction.
  • Selling index futures. Some common futures include the E-Mini S&P 500 (ES), the E-Mini Nasdaq 100 (NQ), the E-Mini Dow (YM) or the Russell 2000 (TF). As a trader, you can buy or sell a financial index today that shall be settled at a future date, that’s a futures contract.

In order to short an Index, you first need to borrow the security from your broker, with the intent of buying it back at a later stage, hopefully at a lower price.

2. Short weak or vulnerable stocks

Another way to intervene in a downward market is to identify weak or vulnerable stocks in order to sell them short. Keep in mind that

How to screen for weak or vulnerable stocks ?

To find weak stocks, check out companies that have recently published either profit warnings or disappointing financial results.

A simple trick to quickly find vulnerable stocks or short candidates: use the Map function on Finviz to check heatmaps of the market. Look for weak sectors (lots of red) and inside that sector pick the ones that show significant decline levels. Check the news around these stocks and you’ll quickly find vulnerable stocks.

There’s a also great book by William O’Neil dedicated to shorting stocks, it’s called “How to Make Money Selling Stocks Short”.

Note that in under certain market conditions, authorities can be lead to suspend short selling in order to prevent panic effects.

It takes real knowledge and skills to short stocks, and this book will give you all the mechanics. It will provide you with a clear strategy and guide you step-by-step with detailed charts.

From setting price limits to having the perfect timing, the advice contained in this book will tell you what to short, when to short and provide you lots of concrete examples.

3. Take leveraged shorts with CFDs

If you want to be a bit more agressive, you can try leveraged bets by shorting CFDs.

CFDs are Contracts for Difference, if you want to know a bit more about them, read this article on “What are CFDs and Trading Contracts for Difference“.

With CFDs you can profit from the rise or fall of an asset for only a fraction of the price it usually takes to buy (or sell) it.

Usually for a CFD trade you only have to deposit a fraction of the full trade’s value.

Let’s take an example. If you want to buy or sell a Tesla CFD and it has a 20% margin requirement on a 420$ stock price, you will only have to put up 20% x 420 = 84$ to open the trade. That is a 5:1 leverage.

Short selling will be a 3-step process:

  1. First, you need to borrow shares of the company you wish to short (TSLA for example); typically you do this from your CFD broker.
  2. Then, you sell the shares on the market at the market price.
  3. Thirdly, you re-buy the shares (hopefully at a lower price) and return them to your broker.

If the price has gone down, you pocket the difference.

4. Buy Leveraged Inverse ETFs

An ETF tracks the performance of an underlying asset. Inverse ETF on the other hand will track the opposite performance of the same asset. They are built from derivatives and usually aim at profiting from declines in the given asset. This article from Investopedia explains them detail.

Leveraged ETF will amplify the variations on the underlying security. A simple ETF usually seeks to replicate the performance of an index, so a leveraged ETF seeks to earn multiples on the index’s performance. For example, the ProShares UltraPro (QQQ) ETF tries to triple the earnings of the Nasdaq. If the Nasdaq gains 1% on a given day, QQQ would theoretically gain 3%.

Leveraged Inverse ETFs will therefore combine the characterstics of both Leveraged and Inverse ETFs, enabling you to bet on a market decline with amplified returns (and risks).

You can check this video to understand Leveraged Inverse ETFs better, securities that combine two investment vehicles in one.

A word of caution, these products are for advanced investors with sound risk management and good understanding of trading mechanics, because they also carry a heavy dose of risk.

What are the Top 5 Leveraged Inverse ETFs?

There are double and triple leveraged ETFs, here are the five most popular:

  1. ProShares Short QQQ (PSQ). This ETF seeks a return that is 3x the return of the Nasdaq-100 index;
  2. VelocityShares 3x Inverse Crude Oil ETN ETF (DWT) to bet on the decline of oil prices;
  3. ProShares UltraShort S&P 500 (SDS) for a two times inverse exposure to the S&P 500;
  4. ProShares UltraPro Short QQQ (SQQQ) for a 3 times inverse exposure on 100 non-financial stocks listed on Nasdaq;
  5. Direxion Daily Gold Miners Bear 3x Shares (DUST) ETF to bet on the decline of Gold.

You can find a more complete list of popular Inverse Leveraged ETFs here.

5. Trade VIX Futures to profit from volatility (advanced strategy)

Sharp market drops usually coincide with a rise in volatility. There’s an index that tracks market volatility, it is called the VIX, otherwise named “The Fear Index”.

You can check this video to understand everything about this index.

Let me say that these strategies are for very advanced traders, who know exactly what they are doing as Futures are complex instruments.

So let’s take a look at the securities that you can buy to bet on market volatility.

Go Long on Volatility Futures Contracts

VIX futures are contracts that track the underlying market volatility. So when the market goes wild, you can actually profit quite a lot by going long on these contracts. They will go up as volatility increases.

VIX futures are standard futures contracts on forward 30-day implied volatilities of the S&P 500 index. For example, a June futures contract is a forward contract on 30-day implied volatility on June expiration date.

Here are some specs of the CBOE VIX Future Contract

  • Ticker Symbol: VX
  • Contract Size: $1000 times VIX
  • Minimum Tick Size: 0.01 (each tick is worth $10 per contract)
  • Contract Months: Available for all 12 months of the year
  • Expiration Date: The Wednesday that is thirty days prior to the third Friday of the calendar month immediately following the month in which the contract expires

There’s no physical delivery so these contracts are cash settled.

Ok that concludes our handful of strategies to trade a bear market. There could be other ways to proceed, but they can be a little risky.

You could also try Put options, but be careful

PUT options are another way to profit from a market downturn. If you don’t know what PUT options are, check out this article.

In a market downturn, PUT options are interesting because with them you can take leveraged short bets on indexes or stocks.

Note however that they will be quite highly priced, and as always they contain a time component that make them a little bit trickier to trade.

And if you want to know more on Options tradings, here’s a list of interesting reads.

One last thing… there’s one strategy you should absolutely consider when a market comes crashing down, it’s buying great stocks on the cheap.

Buy value stocks on the cheap

Listen to Warren Buffet, be greedy when others are fearful.

Bear markets are a tremendous way to buy quality stocks at a faction of their inteinsic value.

That could mean buying quality dividend stocks (check this article on buying dividend stocks).

Phil Town has a great website on value investing, include a Market Crash Survival Guide, I strongly suggest you take a quick peek down there to catch some great Value Investing strategies..

Conclusion

Stock market crashes are usually perceived as traumatic situations. Sure, losses can run pretty steep.

But although you should never try to catch a falling knife , there are many ways you can profit from a stock market crash. You can try to either hedge your losses or take advantage of declining asset prices.

You have to decide if you want to go with shorting individual stocks or go for the broader market. Never forget that these are quite advanced and risky strategies. So before you launch, make sure you have a good grasp of market mechanics. Or try to paper trade them for a while.

I hope this guide has provided you with useful info, drop me a comment below if there are some topics you would like me to cover.

Safe Trading to all.


Further Reading

1 thought on “The Best Ways to Profit from a Stock Market Crash”

  1. Great article. Your blog contains professional content, many thanks for that! This is exactly what. It was very valuable to learn some things, usually a crash is perceived as a loss. Thanks for the options to see things differently!

    Reply

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