What Investing Strategies Allow You to Bet Against a Stock?

Most stock investment strategies bank on shares increasing in value. Betting against a stock, also known as shorting, involves profiting from a stock’s decline in value. There are a few ways to do this. Short selling involves selling borrowed shares at the current price and aiming to repurchase them later for less. Trading put options allows investors to bet against a stock by buying contracts that gain value as the stock’s price falls. Other strategies like investing in inverse ETFs, contracts for difference (CFDs) and shorting futures indexes let investors bet against individual stocks or broad market segments. All these strategies share the traits of complexity and above-average risk.

Whether you want to invest in stock or bet against it, a financial advisor can help you develop a strategy for your portfolio.

Why Bet Against a Stock?

Betting against a stock can serve multiple purposes for investors, particularly those looking to profit from market downturns or protect their portfolio from declining assets. Some investors take a bearish stance on a stock or sector when they believe the company’s fundamentals are weakening or the broader market is overvalued. This may let them profit if the stock’s price falls.

Another reason to bet against a stock is to hedge existing positions. For example, an investor holding a large portfolio of stocks might use short positions to limit losses during periods of volatility or economic uncertainty. Hedging in this way can help balance out risks and protect gains from other investments.

Some traders also engage in shorting as part of a broader speculative strategy, aiming to capitalize on short-term price movements driven by news, earnings reports or macroeconomic events. These strategies require careful timing and market analysis, as betting against a stock carries the risk of unlimited losses if the stock’s price rises unexpectedly.

How to Bet Against a Stock

An investor reviewing investment strategies.

Each method of betting against a stock or the broader market has its own approach, risks and potential rewards. Here’s a breakdown of five common approaches:

1. Short Selling

Short selling is the most traditional way to bet against a stock. An investor borrows shares of a stock from a broker and sells them at the current market price, with the intention of buying them back later at a lower price. If the stock price drops, the investor buys the shares back at the lower price, returns them to the broker and pockets the difference as profit.

Short selling carries considerable risk. If the stock price rises instead of falls, the investor must still buy back the shares at a higher price, losing money in the process. Theoretically, there’s no cap on how much money can be lost in a short sell, as there’s no limit to how high a stock’s price can rise.

Additionally, brokers often require an investor to maintain a certain level of funds in a margin account to cover possible short selling losses. If the stock rises too much, the investor may face a margin call and have to buy back the shares at a loss.

2. Put Options

Put options are another way to bet against a stock. A put option is a contract that gives the holder the right, but not the obligation, to sell a stock at a specified strike price by a certain expiration date. If the stock’s price falls below the strike price, the investor can buy the stock at the lower market price and sell it at the higher strike price, profiting from the difference.

Unlike the unlimited losses possible with short selling, when trading put options the maximum loss is limited to the premium paid for the option. Put options also allow for greater leverage, meaning an investor can control a larger amount of stock with a relatively small investment.

However, if the stock price doesn’t drop by the expiration date, the option expires worthless, and the investor loses the premium paid. Timing is key with options, as the stock needs to decline within the specified timeframe.

3. Inverse ETFs

Inverse ETFs offer a more straightforward way to bet against the stock market or a specific sector without directly shorting individual stocks. These funds are designed to move in the opposite direction of an index, sector or asset class. For example, if an inverse ETF tracks the S&P 500, it will rise when the S&P 500 falls.

Inverse ETFs can be attractive to investors who want to short a broad market or sector without the complexity of short selling or options trading. These funds are easy to trade, available through most brokerage accounts and don’t require a margin account.

However, inverse ETFs are typically designed for short-term use and can lose value over time due to compounding effects, especially in volatile markets. This makes them less suitable for long-term bearish positions. Additionally, some inverse ETFs use leverage to amplify returns, which can increase both potential profits and losses.

4. Contracts for Difference (CFD)

Although banned in the United States, a contract for difference (CFD) is a derivative instrument that allows investors in other countries to speculate on the price movement of an asset without owning the underlying asset. When an investor opens a short CFD position on a stock, they are betting that the stock’s price will fall. If the price declines, the investor earns the difference between the opening price and the closing price of the contract.

CFDs are often used by traders looking for flexibility, as they allow for short positions without the need for borrowing shares or setting up a margin account for short selling. They also provide the benefit of leverage, allowing investors to control larger positions with a smaller initial investment.

However, leverage works both ways – it can amplify gains but also increase losses. Another risk with CFDs is that they are not available in all countries, and trading fees or financing costs can add up over time, especially in highly leveraged positions.

5. Shorting Futures Indexes

Shorting futures indexes is a method for betting against the broader market by using futures contracts. These contracts allow investors to speculate on the future price of a market index, such as the S&P 500 or the NASDAQ.

When an investor shorts a futures index, they are agreeing to sell the index at a specific price on a future date. If the index’s value decreases before the contract’s expiration, the investor profits by buying back the index at the lower price.

Shorting futures indexes is often used by professional traders and institutions as a way to hedge portfolio exposure or speculate on market downturns. The futures market offers high leverage, meaning that small price movements can lead to large profits or losses.

High leverage and potential market volatility makes shorting futures indexes a high-risk strategy. Additionally, futures contracts have set expiration dates and investors need to be mindful of the contract’s terms and timing to avoid being caught by sudden price movements.

Bottom Line

Betting against a stock involves a range of strategies that allow investors to profit from a decline in the price of individual stocks or broader markets. Approaches like short selling, put options and inverse ETFs each offer different ways to capitalize on falling prices, with varying degrees of risk and complexity. While short selling involves borrowing shares and repurchasing them at a lower price, options provide a more limited-risk method by purchasing contracts that benefit from price drops. Inverse ETFs and other tools like CFDs and futures allow broader market bets, offering diverse opportunities for investors looking to hedge or speculate.

Tips for Investment Planning

A financial advisor can help you analyze investments and manage your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Whether you go long or short, you can use SmartAsset’s investment calculator to find out how your nest egg will grow over time.