Contracts for Difference
Contracts for Difference (CFDs) give investors the ability to go short on individual shares or entire indexes. A popular market to trade is the FTSE 100. Depending on your broker you are given the opportunity to trade in contracts or lots which give you exposure to the underlying market.
For example, a contract may give you exposure where you make or lose £10 per 1 point of the index. If you open 1 contract at 7050 and it falls to 6950, a difference of 100 points, you will make £1000. Conversely, if the market rises to 7150, you will lose £1000.
You can also short sell individual shares. When the market falls there are stocks that tend to move more quickly than the rest of the market, these are known as higher ‘beta’ stocks. Also depending on the reason for the sell-off, certain sectors will also lead the way down.
The catalyst for a downturn could be attributable to China for instance, mining companies are highly impacted by Chinese demand and could see a sharp downturn in such an event. Shorting companies like Anglo American, Rio Tinto or BHP Billiton could be a prudent move in this situation.
Generally CFDs do not have an expiry so you can keep them open for as long as you wish. CFDs do incur a small overnight financing charge which is around 3% +/- Libor.
Spread betting offers similar features to CFDs with the added benefited of it being free from capital gains tax.
Options
Put options give investors the ability to profit in the case of a market downturn. Similar to CFDs, options are traded in contracts, however they are fundamentally different as they have expiry dates and strike prices.
Buying a put option is considered as an insurance policy by many investors as you pay a ‘premium’ to protect your portfolio. The premium paid is the total risk the investor will take on.
Diversify
Diversification is always key when investing and having a broad range of asset classes that aren’t highly correlated will protect your overall portfolio in the case of an equity sell off.
A portfolio that is spread across Bonds, Forex, Commodities as well as Equities will fare better than one solely in equities, if the stock market crashes.