Managing Editor’s Note: Our colleague Jeff Brown has been a major AI bull for years now. But now he says many wildly popular AI stocks could fall 50% or more – beginning as early as November 30.
That’s why he’s hosting a special event on Wednesday, November 20, at 8 p.m. ET. There, he’ll reveal why he believes this crash is inevitable. He’ll also explain which types of companies he thinks are most at risk… and share the name and ticker of the wildly popular stock he believes could be next in line to tumble.
Most importantly, he’ll brief you on the strategy he recommends using during this period to profit from the AI crash…
So don’t wait… Click here to add your email to his guest list with a single click.
A wave of euphoria swept the markets after Donald Trump’s win.
The Nasdaq, S&P 500, and Dow Jones jumped to all-time highs. But it wasn’t just stocks enjoying the ride…
The U.S. Dollar Index (which measures the USD against a basket of currencies) hit its highest level since July. And Bitcoin surged strongly, gaining $20,000 in a week.
It’s easy to get caught up in all the hype.
But don’t forget that things can just as quickly turn south. When stocks soar rapidly, a pullback often follows the rally.
So today, let’s look at how to trade the reversals.
Because over the coming months, we’re going to see plenty of swings ahead…
How to Short Sell
One way to capture a stock reversal is through short selling. Hedge funds use this strategy all the time.
It involves borrowing shares and selling them. The aim is to profit by buying them back (and returning the shares to the original holder) at a lower price.
For example, say you want to short Nvidia (NVDA). It’s currently trading around $148. You borrow 100 shares and sell them, earning $14,800.
You still have to return 100 shares to the lender, though. NVDA’s price falls to $140, so you buy back 100 shares for $14,000 and return them. You get to keep the $800 difference in the prices as profit.
That’s the ideal way for this strategy to work out. It comes with challenges, though.
For a start, a stock can only fall to zero. So the profit on any short trade is capped.
However, a stock can technically rise to infinity – which means your potential loss is unlimited.
Consider someone who shorts 1,000 shares at $50. They’re short $50,000 worth of stock.
But if the share price rallies to $60, their exposure would increase to $60,000. If they have to buy back those 1,000 shares at that price, they’d be down $10,000.
You can see how a runaway rally could cause devastating losses…
Remember Herbalife?
You only need to revisit the infamous case of Herbalife – a nutritional supplement maker – to see how this plays out…
Bill Ackman’s Pershing Square Capital started shorting Herbalife shares back in 2012, expecting them to go to zero.
And initially, things went his way.
But rival Carl Icahn took the opposite view. He built up his stake to eventually own around one-quarter of the stock.
Herbalife soared dramatically in 2017. And Ackman finally abandoned his position. After his five-year battle, Ackman lost close to a billion dollars.
Ouch. That’s why I prefer a different strategy for betting on downside…
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Managing Risk
Rather than shorting shares, I use put options instead.
A put option increases in value when the underlying stock falls.
It enables me to profit from a stock falling without having to borrow shares.
And unlike shorting shares, I always know my maximum risk with options. That’s the premium I paid for the option.
Even if the trade goes terribly wrong and the stock price soars, that maximum loss doesn’t change.
And we’re only risking a fraction of the amount compared to shorting shares. So we can re-enter the trade later if the initial position doesn’t go our way.
Naturally, options do have their own drawbacks… They expire, so you need to get the downside move you’re looking for in good time. Otherwise, time decay erodes the value of your option as you get nearer to expiry.
And if the stock rises instead of falls, for example, your option can expire worthless.
But a put option enables you to profit from a down move while putting a hard limit on your potential loss.
Right now, the markets are caught up in the elation of a Trump win. But that will eventually die down.
When that happens, put options are the ideal way to profit from any pullback.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict