This week was a brutal week for the markets. The TSX lost close to 1000 points. The S&P 500 and DJIA were also down, and so was almost every sector – especially commodities. Now in general terms, it is easier to profit in a rising market, but you can still profit in a down market. Here are several ways:

1. Short Selling
   Short selling (or shorting) is basically selling a stock now with the expectation that the price will go down, at which time you buy. It’s the same principle as ‘buy low, sell high’, except in the reverse order. Shorting can be very risky because it essentially involves selling something you don’t have. Your brokerage firm will require you to maintain a certain level of cash to buy those shares. If the price rises substantially, you may be forced to add more funds to your account (called a ‘margin call’) or even be forced to buy those shares at a loss. I have never shorted a stock due to the margin requirements.
2. Put Options
   A way to control a stock without owning it outright is to purchase an option. A put option is the right, but not the obligation, to sell a stock at a predetermined price, by a specified date. If the underlying stock price falls, you profit. My view is that buying short term options (having an expiry of 9 months or less) based purely on speculation, is extremely risky. You may be able to generate large, leveraged returns, but you also have a real risk of losing your entire investment. However, if you own the actual stock, then I think using a put option as a hedge against a drop in price is a smart move.
3. Bear/Inverse ETFs
   My preferred method of investing in a down market is to buy bear ETFs (more commonly referred to as ‘inverse ETFs’ in the US). Bear ETFs track the downward movement of an index, commodity, currency, etc. For example, if the price of oil drops, the price of a bear ETF that tracks oil will rise. Bear ETFs and ETFs in general offer the advantages of a diversified, managed fund for a low fee.

   Here are some Bear ETFs to check out:

   S&P/TSX 60 Bear Plus ETF (TSE:HXD)
   NYMEX Crude Oil Bear Plus ETF (TSX:HOD)
   Short S&P500 (AMEX:SH)
   UltraShort Oil & Gas (AMEX:DUG)
   UltraShort FTSE/Xinhua China 25 (AMEX:FXP)
   UltraShort Basic Materials (AMEX:SMN)

On one last note, the above mentioned ways will be more expensive in a down market and cheaper in a rising market – thus making them good hedging instruments in a rising market. If you’re still awash with what I just said, then think of it this way – insurance is much more expensive when your house is on fire.