The tried and true formula for successful sales, "buy low, sell high," applies equally to financial markets. Traders use various types of transactions to achieve this, including short positions (betting that the price will go down) and long positions (betting that the price will go up). These strategies are commonly referred to as "short" and "long" in professional circles. This article will explain the meaning of these terms, their purposes, and how they work.
What Is A Long
Traditionally, a long means the purchase of securities on your brokerage account. Longs can be short-term - buying assets for a couple of days or even minutes - or long-term, lasting up to several decades. With a short-term long, investors plan to make money on asset appreciation or dividends; with a long-term long, they plan to earn passive income with a steady dividend payment or profit from the higher difference between the security's purchase and sale price.
When an investor purchases a stock, they "open" a long position. As long as the investor holds the stock in their portfolio, they "hold" a long position. When the stock is sold, the long position is closed.
For example, an investor reads the news that a company's earnings have multiplied. The investor is confident that its stock price will rise in the near future on that backdrop. At the time of the placing position, the price of one share is 100 dollars, but the investor only has 1000 dollars of available capital. They use their own money to buy 10 shares and open an additional 30 uncovered long position. If after a while the price of the stock increases to 105 dollars, the profit will amount to 150 dollars. If they had traded using their own funds only, they would have made only 50 dollars in profit.
What Is A Short
Short positions involve betting against the market by predicting that the price of a security will decrease. For instance, if an investor believes that Tesla's shares will drop due to reports of delivery issues and missing analyst forecasts, they may place a short position when the price is $185 and close it once the stock drops to $170. Depending on the number of shares traded and leverage, the investor can make a profit of $15 per share, minus commission. While short positions can attract traders seeking quick profits, they are also risky and can lead to financial market destabilization if too many are opened. Additionally, short positions rely on a rapid decline in share prices, which only experienced traders can accurately predict. Laws may also restrict shorting when it is deemed necessary.
To profit from shorting, it is crucial to wait for a reliable signal indicating that the stock price will decline. These signals are often visible on charts and can include patterns indicating the end of a growing trend.
Difference Between A Long Position And A Short Position
To open a short position is to make a profit on a decline in the value of certain stocks. In this case, the investor uses margin trading and opens an uncovered position in which securities are in debt: the investor sells securities that they do not own. They expect that their value will decrease and they will buy them back at a lower price, after which they will close the uncovered position. Opening long positions is based on an asset's price increase. Such trades are usually made if investors believe the asset is undervalued.
For example, if there is a general negative market backdrop and there has been a general drawdown. If the selected company's performance has not deteriorated - it still has a sales and supply market - its stock price may fall due to investor emotion. Such a situation can be a reason to buy more assets and, by using a speculative strategy and opening positions, earn manifold.
Short positions are much riskier than long ones, so novice investors should not try to make money on falling stocks. Quotes may rise contrary to expectations, which may lead to a margin call, a portfolio situation in which funds need to be deposited or a part of positions closed. In such a situation, the investor is forced to buy the stock at a higher price than they sold it, which causes a loss of funds.
What You Need To Know Before Opening A Position
Before you open either a short or long position, you need to study the performance of the business behind the shares, because the market is volatile, and even professionals find it difficult to guess where the share price will go in the short term. To reduce risk and make more accurate decisions, you need to monitor the stock market and not panic when the price falls.
However, even if a company is cheap by multiples, that doesn't mean the stock will necessarily rise in price. Therefore, before adding certain stocks to their portfolios, investors study a company's financial statements, review analytics, and stay tuned to the news.
Read more about how to properly analyze stocks in our article "Fundamental Analysis: A Complete Guide" - a minimum that every investor should know.
Simultaneous Short And Long
At first glance, it might seem that long and short trading are mutually exclusive operations. However, there are a number of possibilities to open long and short positions simultaneously. One of them is the boxing technique. The idea is to simultaneously hold long and short positions: they must be of equal size. For example, you anticipate a decline in a certain stock and sell longs it, leaving shorts only. But over time, your prediction fails, the stock does not fall in value, and you buy the long back. When they finally do go down in value, you sell the short, cover your costs, and make a profit. However, many companies do not allow simultaneous longs and shorts, which means such transactions are quite risky and require multiple accounts or brokers.
Long Position Vs. Short Position: Which Should You Use?
It is impossible to state unequivocally that this or that position is better and more profitable. Some traders prefer to open only long positions, counting on price movement upwards, while others prefer shorts and get fast profit. Some open both long and short (sometimes even simultaneously). There are a lot of opportunities to make a profit in trading, and in certain situations, a long and a short are ideal tools to do this.
Both positions are not without risks. Profits from long positions can, in some cases, be expected for a very long time - and then they may never come. The shorts might not "work out" because the market decline forecast did not come true. However, traders should not ignore any of the positions. Trading provides many opportunities for both bulls and bears.
The Bottom Line
In conclusion, understanding the difference between long and short positions is crucial for any investor looking to make money in financial markets. A long position involves buying securities in the hope of earning a profit from appreciation or steady dividend payments, while a short position involves betting against the market and predicting that the price of a security will decrease. Both strategies carry risks and require careful research and analysis before opening a position. It is important to remember that even experienced traders can struggle to predict market movements in the short term, so patience and a long-term investment approach are often key to success. Finally, while it is possible to simultaneously hold both long and short positions, this technique is complex and can be risky, requiring multiple accounts or brokers.