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Getting rich in a recession

Updated Thursday, 5th June 2008

Making money in a depressed stock market - is it possible to get rich in a recession?

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You might think the obvious way to make money in a recession is to be involved in the production or sale of low cost versions of essential items – such as pizzas, bread or pork sausages. But you can still get clobbered by rising costs – petrol, utilities and, when your staff have to pay higher prices, on rising wages too. A more indirect way is to be in businesses that positively profit from others’ distress – here the obvious ones are firms that specialise in sorting out the financial messes that individuals or companies get into. So, bailiffs and company receivers do well in a downturn. Closing down sales at Woolworths Creative commons image Icon nutmeg66 under Even when a business closes, there's still a deal to be done

A more straightforward way, though, is to make money indirectly through the stock market. In the old days, it was quite hard to do. If you held shares and the market went down, you lost money. Now, you can easily take a position which makes money when a share falls in price. You don’t even have to be a stock market professional.

You can use futures or options – so called ‘derivative products’ which are linked to the underlying asset you want to trade. If you think, for example, that the FTSE 100 stock market index is going to go down, you can sell futures contracts on the index. Your brokers will require cash from you, to protect themselves if you are wrong, but essentially, you hope the index will go from say 6000 to 5500 and that what you sold at 6000, you can buy back at 5500, pocketing a profit of 500. The more futures contracts you sell, the bigger your profit.

"whether we are living in good times or bad, we can make money from the stock market"

Sounds too good to be true? The problem is – what happens if you are wrong, the FTSE 100 rises to 6500 and you have to buy back at a higher price than you sold? A lower risk way is to buy a put option. For a small premium, you have the option to sell the FTSE 100 say at 5750 when it is currently trading at 6000. If you are right and the index falls to 5500, you can effectively close out your position for a 250 point gain, less the cost of the put option. This way, if you are wrong, you can simply walk away, worse off only by the put option premium.

Investment professionals use futures and options to bet that prices will fall all the time. George Soros is famous for having made a fortune from selling the pound sterling just before it left the European Exchange rate mechanism. More recently, two traders at Goldman Sachs – Josh Birnbaum and Michael Swenson made money out of the ‘credit crunch’ – they sold products linked to the sub-prime market and bought back when prices had fallen. As a result, Goldman made around $4 bn from this strategy and Josh Birnbaum has set up his own $1bn fund trading sub-prime mortgages.

What can you do when markets have already fallen? The answer is invest in a so-called vulture fund which buys securities which have fallen dramatically in price, in the hope that they will recover. So, whether we are living in good times or bad, we can make money from the stock market. The only problem is getting your timing right!

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The opinions expressed are those of the author and are not held by the Open University or BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.

 

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