Every day, the stock market seems to continue its precipitous drop towards worthlessness, crushing hopes, dreams, and investors in a flurry of dizzying price movements. Yet there is an answer; a light in the darkness, used by the masters of investment to generate excess returns even ” no, scratch that, – especially in falling markets like this one.

Masters of short term stock speculation have long known about an ill-understood trading technique shunned by the masses. This technique makes money as stock prices fall, rather then profiting as they rise. This technique is known as shorting stock. Unlike purchasing a stock, where you buy it, and then hope that it goes up in value, or that you can collect the dividends from the stock far into the future, shorting a stock is a simple technique the masters use when they believe the stock will go DOWN. A risky play under normal conditions, but in a market like this, where most everything is dropping like a rock, its much safer then buying stocks.

While counter-intuitive, shorting stock is less complicated then you might think. The goal when shorting stock is the same as when buying; your trying to buy low, and sell high. The only difference is that you do it in the other order. You sell stock today, and you buy it tomorrow (or some other time in the future), hopefully for less. By doing so, you make a profit equal to the difference between your buying and selling prices.

An example… In late August 2008, Ford was trading for around 4.50. If you decided to short 100 shares of ford at that point, then you would borrow 100 shares of Ford from your broker and sell them for a total of $450. In late October 2008, Ford was down to the 2.25 range. At that point, you could buy back the 100 shares you sold for $225, return the 100 shares to your broker, and all in all, you made $225. In essence, you sold high, then bought low. Its just like buying low, and selling high ” it just operates in reverse. This would be a good time to re-read this paragraph, its that important.

A more abstract, but ultimately easier way to think of shorting is a way of owning a negative number of shares. If when you own 10 shares, and a stock goes down by $100 , you lose $1000. If you own negative 10 shares, and a stock goes down by $100, you gain $1000. Simple as that. Naturally, an increase in price works the same way ” a price increase means owning a negative number of shares leads to a loss, but in a bear market, thats a rare thing.

Even still, shorting stocks has risks. If you choose the one stock of 100 that is about to start trending upwards, you could lose some money on that. Different sectors of the economy may also be effected by events that cause exceptions to the everything goes down in bear markets rule. The recent auto bailout could feasibly cause industrials to go up for a while, so shorting industrials could choose to be a bad choice. The biggest risk is that the bear market turns into a bull market while your not paying attention ” that could rack up losses on many positions at once.

A typical risk-management choice many professionals use is the 5% rule. When your trading stocks, dont risk more then 5% of your portfolio on any one position, and preferably less. So with the $20000 portfolio, risk no more then $1000 on a trade. This doesnt mean you cant invest more then $1000 per trade. It just means that your stop loss should be triggered before $1000 is lost. So if you short a stock at $20, and have a stop loss at $25, then you can buy up to 200 shares (far more then the actual value of your portfolio). If your time span is shorter, then you should use a smaller percentage, while if your timespan is longer then a couple months, the 5% rule could be adjusted as high as 10% (for the risk-tolerant).

The current trend in the market is down. This is the most important thing to keep in mind when deciding where youll invest your money at this point in time. When the stock market is in bear market mode, almost all stocks are moving downwards. When this happens, it doesnt make sense to buy-and-hold like the masses. A far more productive approach is to find out whats working and to use that method instead. In the context of a bear market, the easiest way to make money is to short stocks or etf’s.