Even yoda might have trouble figuring out the current market environment. In a world of falling prices, how can wealth be protected? I have some news for you. Even in a falling market, wealth can be not just preserved; it can be created. With just a few simple techniques, Ill show you how to supersize your portfolio.

The technique Im referring to happens to be popular with hedge fund managers ” those stock market whizzes pulling millions of dollars a year in exchange for managing their portfolios. This technique was also responsible for the creation of many a millionaire during the 1929 stock market crash. Yet this same technique is shunned by the public, due to its intrinsic counter-intuitive nature. Still, mastery of this technique ” and its a lot simpler then you may think ” its essential to doing well in bear markets such as this one.

To short a stock is essentially to sell it, and then buy it at a later date. Counter-intuitive, no? In the shorting process, you borrow the stock from your broker, sell it on the open market, and when the price has fallen sufficiently, you buy it back again, and return it to your broker.

An example… In late September 2008, Bank of America was trading for around $35.00. Shorting the stock at that point in time wouldve been extremely lucrative, as by late November, it was trading for around 15.00$. Shorting even 100 shares of bank of America, you would have made 2000$ (100 shares * $20 price drop). The process is something like the following. 100 shares of the stock, in this case, bank of America are borrowed from your broker, and then sold. You pocket the $3500. 2 months later, you buy back the shares for $1500, and return them to your broker, keeping the $2000 difference between what you bought them for, and what you sold them for.

Another way to think of shorting stocks is to own a negative number of shares… If you own 100 shares of a stock, and it goes down $10, then you lost $1000. If you own -100 shares of a stock (or your short 10 shares of a stock), and it goes down 10$ then you gain $1000. Of course, if the unthinkable happens, and the stock appreciates by 10$, then your down $1000 (What, did you think it was riskless?).

Regardless of how you play the markets, an eye must be kept on the most important element of all ” risk. While shorting helps to remove some of the systematic risk from your portfolio ” a portfolio composed of both buying stocks, and short stocks, is less venerable to a market crash ” it does carry its own unique risks. Especially in a bear market, it pays to watch the news on your shorts. Any good news that comes out may raise the stock price of those that your shorting, and if a stock isnt going down anymore, its not a good stock to be short. The bigger risk to your short positions is the end of a bear market. When the new bull market ends, many short positions will quickly swing towards unprofitability, and so you must be quick to close them.

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).

When it comes to stock picking, some people would call this a challenging market. And traditionally, we have been taught that buying low and selling high is the idea scenario, so looked at from that sense, perhaps it is a challenging market. Or is it? With everything covered already in this short document, you have already learned that a so called “challenging market” can be a bonanza for those who have learned how to short a stock or etf.