Best Stock Funds to Make Money Investing in a Bad Stock Market

Anyone can make money investing in stocks or stock (equity) funds in a good stock market – but few make money investing in a bad market. If 2014 and/or 2015 turn ugly, there’s a little “secret” about the best stock funds you should know if you are into stock investing.

I competed in the last CNBC international stock investing contest and beat 99.9% of the competition. This was in late 2011, and the field of competition included about half a million investment portfolios (trying to win the $1 million first prize). The market took a hit, and that’s what I was betting on… so I loaded up on the best stock funds available at the time. Secret: You don’t make money investing in equities (stocks) by trying to pick winners in a bad market. You make money by betting against the market. And that’s what I did, taking advantage of all the financial leverage the contest would allow. Most investors do not know that you can bet on the downside.

With the market UP about 150% since the lows of 2009, the years 2014 and 2015 could spell trouble for stock investing and investors who think they can pick winners. In a BEAR market the VAST MAJORITY of stocks fall and the biggest winners of yesterday become today’s big losers. Period. The good news is that these days the process of betting against the market is simpler than ever. All you need is a brokerage account with a major discount broker. Then the best stock funds to make money investing in stocks in a bad market are available to you at a cost of about $10 a trade.

These best stock funds are called “inverse equity” funds. Simply stated, they are index funds called ETFs (exchange traded funds) and they trade just like any other shares do. To get your feet wet, I’ll give you an example. The symbol SDS is a bet that the market (as measured by the S&P 500 Index, which represents the 500 biggest, best known corporations in America) will FALL in value. If the stock market (the S&P 500 INDEX) falls 1% in a day, SDS should go UP 2% (inverse leverage of 2 to 1). If the market in general falls 50% in 2014 and/or 2015, the price of SDS should go UP 100% (a double).

During the great DEPRESSION of the 1930s, some investors got rich as the market unraveled. In 2000-2002 and again in 2007-2009, the market tanked and some folks got rich by “short selling” or taking a “short position”… by betting against the market. Today, taking a short position is easier than ever before… and even the average investor can do it with inverse equity ETFs. You simply buy them and hope the stock market falls. Then, you try to time it so you sell them for a tidy profit if it does. In the old days the process of selling short was a bit more involved.

Most of the time stock investing is lucrative, but every few years it gets ugly. You will never make money investing in stocks on a consistent basis. No one does, and not even the best stock funds in search of the best companies to own come close… because they are designed to bet on the upside. When the tide for equities goes out, at least 90% of stocks traded are losers. If you want to beat the stock market you’ve got to know when to hold them and know when to fold them. If you really want to make money investing in stocks you’ve also got to know when to short them.

These best stock funds for a bad market (inverse equity funds) are NOT for average investors who are investing money for retirement passively. These are only the best stock funds for those who want to play the stock market game actively (with simplicity) to do the best that they can. Stock investing is a big part of the game if you really want to put your money to work and make it grow. If you can make money investing in stocks in the bad years you’ll be WAY AHEAD of the game. But it will require some time and attention on an ongoing basis.

Looking at 2014 and 2015, I think that the party may be over. If you are heavily into stock investing vs. bonds and safe investments, I suggest you take some money off the table. If you want to be more aggressive and try to make money investing in stocks in what could be a bad market I suggest giving inverse equity funds a try. The financial leverage they offer is 2 or 3 to one. You can get more leverage than that with stock options called PUTS, but these can be much riskier… because here you pay a premium for time and eventually they EXPIRE on a given date and can become worthless.

What I am calling the best stock funds for a bad stock market do not expire. They are simply stock index funds on steroids that move opposite in price to the stock market in general. I suggest you start by experimenting with SDS before you try to make money investing by going “short” part of your investment strategy for 2014 and beyond. If you find that you are not comfortable playing the short side – you can always sell and get out.

How Long Does It Take To Make Money In The Stock Market?

The answer to this question depends on so many factors. It is next to impossible to predict how long it will take for one to make money, as the stock market is unpredictable. How long it will take for you to make money depends on factors like the type of stock you bought, the company one has invested in, and the timing of buying or selling of stocks. One thing you have to understand is that stock market is not a fast money system, and it may take a while before you can start enjoying your investment. It is important for you to know how stock markets work, so as to know how long it will take for you to make money.

How Does The Stock Market Work?

As you know the stock market is a place where people buy or sell shares of a company. Once a company is branded as a public operated company, it releases shares in terms of stocks so that people can invest in the company. Once you buy the stocks of the company you automatically own a small part of the company. People earn from the company when the company increases in their profit if the company makes loses then also the stocks depreciates. You earn from the stocks in two major ways; you can earn when your stock appreciates and gains value or through dividends. Most companies pay their shareholders dividends from their profits either on quarterly, semi-annually or annual basis depending on the type of stock.

Different Types Of Stocks

The type of stock you buy has a lot to do with how long you will have to wait to get your investment. There are different stocks offered by the public operated companies but there are two major stocks that you will come across in the market.

1. Common Stocks

The common stock is the first major type of stock out there. As mentioned above, buying of company stocks gives you some sense of ownership of the company. When it comes to common stocks the shareholders own voting rights in any shareholders meeting, although this depends on the amount of shares that one has. The shareholders are given the liberty of voting one vote per share. When it comes to earning from the common stocks, you will get dividends although the dividends are not guaranteed by the company. The dividends are calculated in a variable rate. When you invest in this kind of stock, you will receive your dividends after the other preferred shareholders have received their amount in full.

2. Preferred Stocks

These are stocks that give you some degree of ownership although the stocks do not give the shareholders voting rights. The preferred stocks are calculated on a fixed rate. These stocks come with great benefits, for example, you will be paid first before the stock shareholders in an event of liquidation. Since the dividends are calculated on a fixed rate, it is easy for you to get a lot of money by buying many shares in the company. With these stocks the company can buy the stocks back anytime.

How Do Stock Prices Go Up Or Down?

This is a very important question to ask if you want to determine when you will get your investment back. The stocks are unpredictable and they are constantly changing their value but you can still predict how the stocks are trading by looking at the supply and demand concept. This concept dictates that once the demand is high the supply goes high and when the demand goes down the supply goes down. When it comes to stocks, the supply and demand concept work the same way, when the demand for a certain stock is high, that is there are many buyers than sellers the price of the said stock goes up. On the other hand the demand of a stock goes down when there are more sellers than buyers which make the prices of the stock go down.

Factors That Influence the Stock Market

Stocks prices are usually affected by certain factors, directly or indirectly. Some of the factors are predictable and others are not. It is therefore very important for you to know these factors so that you can determine the correct time to trade your stock.

Internal Factors And Unpredictable World Events

The internal factors affect the stocks directly. These are factors that are generated from inside the company and they include; introduction of a new products, mergers of companies, suspension of dividends, fraud, negligence, earning reports and many more. You need to know the internal factors firsthand before investing. When it comes to world events, there are certain events that can adversely influence the value of a stock. Events like war, terrorism, natural disasters like hurricanes. The world events influence the trading of the stocks as the investors look to invest of stocks with less risk. The events may directly or indirectly influence the stocks.

Interest And Exchange Rates

Here is how it works with the interest rates; during inflation the companies raise the interest rates to combat the inflation. In turn the investors sell their stocks at a higher rate to the government and secure the bonds hence protecting their investments. This can influence the value of the stock in the long run. The exchange rates on the other hand, have a direct impact on the stock value. The exchange rates do influence if investors will invest in a country or not, this affects the prices of the stocks of the said country. There are short-term movements and long-term ones. The short-term movements are influenced by things like events and news while the long-term ones are brought by the market forces of supply and demand.

The bottom line, the period of time you have to wait to make money varies depending on the type of stock and the company you have invested in. The time you bought the stocks also play a huge role in determining how long it will take to make money in the stock market.

Playing In The Stock Market Casino

As an investment advisor, I’m not supposed to admit that stock investing amounts to gambling. The industry line is that if you invest in good companies or mutual funds, keep a long-term perspective and ignore the dips along the way, everything will turn out fine. For a long time I tried to ignore that little voice in my head that said “something’s not right.” After all, stocks have outperformed all other asset categories over the last 100 years, the stock market always recovers from crashes, Warren Buffett is a buy-and-hold investor. Most of the conventional wisdom and rules-of-thumb have a sizable element of truth or they never would have become so widely popular and embraced, but something still doesn’t seem right.

There is an ugly side of investing that creates that uncomfortable feeling. According to market data put together by Kenneth French at Dartmouth College, large cap stocks have experienced drops of 25% or more about 10 times over the last 85 years. That averages once every 8.5 years, although there are some long stretches where there were no steep drops and other stretches where they came in clusters. If you started investing shortly after a market drop (say, 2002) your investments performed significantly better than if you began your investment life shortly before a drop (2000 for example). The Nikkei-225 index (Japan) is currently down about 75% over the last 22 years, which has ruined the retirement plans of an entire generation. Of course, Japan’s problem was an over-heated real estate market, multiple recessions, excessively high debt, and an aging population. That could never happen in the U.S. Finally, it is very difficult to invest like Warren Buffett. Goldman Sachs has never offered me perpetual preferred stock with a 10% yield. I also can’t afford to buy a business, install the management, and hold them accountable for superior performance.

The truth is that investing in stocks is a gamble regardless of your timeframe. The best fundamental indicators can be rendered meaningless by hedge funds doing flash trades with super computers or a change in governmental policy that alters the rules of investing (see General Motors). Like any casino, someone has the “edge.” In Las Vegas, the edge in every game belongs to the house, which means if you play long enough the house will eventually take your money. With respect to stock investing, you may not actually lose your money, but if you play long enough you will eventually experience a significant down market that will take back a chunk of your wealth. As an average investor, you do not have the edge. Hedge funds can have an edge by front-running stocks with flash trades. Politicians can have an edge by legally using inside information. Warren Buffett can have an edge by taking advantage of deals that are not available to normal people. The average investor is on the other side of these trades and is completely exposed to the whims of the market.

An Example: Covered Call Strategy

To demonstrate what the lack of an edge looks like, let’s use a typical Covered Call option strategy, which is becoming very popular as investors look for sources of income and additional yield. A Covered Call strategy involves buying shares of stock and selling Call options to generate additional income. A typical position might look like this:

Buy 100 shares of Apple stock for $450/share

Sell a $475 Covered Call option contract for $9.20/share

In this example, the Covered Call option will expire in 75 days. If Apple stock stays flat for the next 75 days, the investor will pocket $9.20/share for an annualized return of 9.9%. If Apple shares rise above $475 on the option expiration date, the investor keeps the $9.20/share and participates in another $25 of share price appreciation for an annualized return of 36.0%. If Apple shares fall, the sale of the option provides $9.20 of price protection, so the investor would not start losing money until Apple drops lower than $440.80. The argument for this strategy is that selling Calls provides additional income in a flat or rising market, and some amount of downside protection in a falling market. It’s the best of both worlds. So why would a casino take the other side of this trade?

Let’s consider the risk profile for this Covered Call position. As the stock price rises, the short Call position loses value at an increasing rate until it is falling at the same rate that the stock is rising. As the stock price falls, the value of the short Call gains value, but is capped at $9.20/share (the price collected for the Call when it was sold). The net effect of combining a long stock position and a short Call position is that profit resistance increases when the stock price rises, and protection decreases as the stock price falls. In other words, if the stock price happens to skyrocket you will have limited profit potential, and if the stock price drops sharply you will have almost unlimited loss potential. This is exactly the kind of position the market wants you to have because the edge is clearly on the side of the market.

The Market Maker’s Side Of The Trade

The job of a Market Maker is to provide liquidity to the market by accepting buy and sell orders for stocks and options, thus “making a market”. A Market Maker must always protect his (or her) account by closely controlling the potential loss. If his account blows up because a stock moves in the wrong direction or an unexpected catastrophic event crashes the market, his job is over. The secret to survival when your career is based on trading stocks and options day in and day out is to tightly limit potential losses and maintain an edge on the market. It’s that simple, and it’s the same philosophy as any casino in Las Vegas.

A successful Market Maker is not going to have a portfolio full of Covered Call positions with limited upside and unlimited downside, but he may take the other side of the trade. Let’s consider what that would look like.

Sell 100 shares of Apple stock for $450/share

Buy a $475 Call option for $9.20/share

The combined position described above is a little better from a probability standpoint. If the short stock position loses value due to the stock price rising, the potential loss is limited by the rising Call option value. If the stock price falls, the short stock position gains value and the option price approaches zero, creating an increasing profit potential. You may recognize that a position with limited risk from rising prices and almost unlimited profit from falling prices is exactly the description of a Put option, and in fact, the opposite of a Covered Call position is a synthetic Put. If you’re still following this, you’ll realize that a Covered Call is therefore the same as a short Put option, which most people would immediately recognize as being very risky.

There is still a problem with this position that a Market Maker would not like. If he guesses wrong and the stock price moves higher he loses money, even if it’s a limited amount. If nothing else, it just doesn’t feel good to lose money, so let’s improve the position by adding another Call option.

Sell 100 shares of Apple stock for $450/share

Buy two $475 Call options for $9.20/share

With the improved position above, the odds of making money are greatly increased and the market edge has shifted in our direction. If Apple stock crashes, we make a lot of money due to the short stock. If Apple stock soars, the 100 shares of short stock cancels out one of the Calls, but we are still left with a Call option that will make a lot of money. However, if the stock doesn’t move, the options will gradually lose time value and we will eventually lose the amount we paid for the options. Therefore, we still don’t have the edge, but we also aren’t holding the sucker bet of a Covered Call (i.e. short Put). Actually gaining a positive edge requires adjusting the position from time to time in order to capture value in relatively modest price moves in the stock, while maintaining the potential for big gains. This goes beyond the scope of this article.

Improving Your Chances

If you decide to try your luck at Black Jack and the extent of your knowledge is that the objective of the game is to reach 21, the dealer will probably take all of your money in fairly short order. The best way to play Black Jack is to be the dealer. The second best way is to learn the subtleties of the game, memorize the odds for any given combination of cards, and have an enormous capacity to keep track of what cards have been played (i.e. count cards). If you do this well enough, the casino manager will conclude that you have captured an edge and will promptly kick you out.

The best way to invest is to have the clout and wealth of Warren Buffett, or the resources and special privileges of a hedge fund, or become a U.S. Senator. The next best thing for most of us is to learn to recognize when we are giving away “edge”. Although most of us do not have the time and resources to invest exactly like a Market Maker, there are techniques we can utilize to avoid handing over a sizable portion of our money to the market on a regular basis.

In a casino, you can’t beat the odds forever. The same is true with investing.