Like how did they make money by predicting it ? what was the strategy?
In: Economics
There are ways to make money from a company (stock) or index (collective of companies) going down. Most commonly this is short selling, but there are other ways too. The most classic example of profiting from a market crash is what Michael Burry did, as shown in the Big Short, where he predicted that the market would crash and made tons of money from it. So how did he do it?
He predicted the subprime mortgage crisis. What this means was that he looked at the data and realized that everyone and their mother was getting mortgages that they were not likely to pay back. Since these were handed out with reckless abandon, this created a huge issue for banks in that the chances that a large part of their loans would not be paid back were high. This would create a huge deficit and a huge problem as a whole. Michael Burry could see that and he persuaded Goldman Sachs and other firms to sell him credit default swaps against subprime mortgage loans, or in layman’s terms they were insurance in case these loans defaulted massively. At the time most firms laughed at him. The housing market was at all time highs and Burry managed funds from many investors, many of whom disagreed with his choice and fought to take their money back from him. He persisted and around a year later the market crash happened which meant that Goldman Sachs, as well as other firms, now owed him money.
Short selling is another general way in which money is made on the way down. You borrow stocks from a stockholder at the current price assuming the price will drop. You sell these stocks for the current price when you borrow them and when the price drops you buy them back and give them to the person you borrowed them from, if the price has fallen, you keep the difference.
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