What is “Short” and “Long” in Trading?
Short position, long position, shorting stocks, and longing them – what do all these mean?
Before we get down and explain to you the concept of short and long in trading, it’s important that you know a few key points first:
- Some people buy stocks to watch them grow over a long period of time, and some buy them and sell them over a short period of time, this is NOT the short and long we are talking about.
- Investing vs Trading: In finance, investing usually refers to those that buy and hold on to a certain asset for a long period of time (years, decades or more) to see the value grows, while trading refers to those that buy and sell asset over a shorter period of time to make profit from
Long vs Short
What is a “Long” Position?
A long position is pretty straightforward, whereby you purchase an asset, you see the value grows and then you sell it to gain profit. It could be in a span of a day, a week, a month or perhaps even more (although traders usually don’t hold their asset that long).
The key point is, regardless of how long you hold the asset, as long as you buy the asset (stocks, bonds, etc.) you are considered to be in a long position.
“Well, why is it called ‘long position’ when I can just sell it within minutes of purchase?”
The answer is that people on Wall Street love to use lingo that sometimes doesn’t make much sense.
What is a “Short” Position?
If a long position is where you’re sitting there and hoping for the stock to rise, shorting is where you hope for the stock to fall.
“How can anyone make a profit when the price of something falls?”
The way shorting works is as follows:
A thinks that stock XYZ is going to fall. A doesn’t own any XYZ. Will A just see it happens as she gains nothing from it? No way!
What A does is that she borrows 1000 stock XYZ from her broker, B, who owns the stocks. What A then do is that she sells all the stocks she borrowed to the market, say, at the price of $1000 today. Now A owns $1000 with no stocks.
The very next day, stock XYZ crashed like nuts and the price for 1000 XYZ is now just at $500. Well, A borrowed from B, right? Is she just going to walk away with the $1000 she just made?
Debt is debt! So, what A does is that she will then have to buy 1000 stock XYZ from anyone and give that stock back to B, only that this time when she buys the stock, it is only half the price. So, she gets to keep the remaining $500.
On a side note:
If you want a fun way to understand more about how big can this ‘short business’ goes, you can watch the film The Big Short – from Margot Robbie in a bubble bath explaining to you about subprime mortgages up to Anthony Bourdain using fish stew to explain collateralized debt obligation (CDO) – worth the time!
Another thing… Options Contract.
Well, that was the general explanation. When you go for an options contract, it’s a bit different.
Now, if you don’t know what an options contract is – it is simply A paying B to get into a contract which allows A to buy assets from B at a certain price at any time until the contract expires. Yes, you can always extend the expiry date (with more payments of course).
Where’s the catch in this contract? Well, A can buy a supposedly more expensive asset at a lower price, and he can also choose to not buy – but all in all, he already paid for the contract price. As for B, he may have to sell something expensive for less, but he still got the contract price (although the contract price could be relatively smaller than selling stocks at a higher price).
So, in the options contract’s lingo, when you are A – the person who buys the option contract – you are now considered going long. Mainly because you’re expecting the price of the asset to go to a certain high in the future – hence, long.
If you are person B – the one who sells this contract to others – you are considered short because it is in your best interest if the stock price falls: if person A choose to still buy it, you’d sell cheap stocks at a higher price while getting the contract fee. If A choose not to buy, you still get to keep the contract fee.
Again, if this is confusing – just bear in mind that it’s only lingo. As long as you understand how people make a profit when the asset value goes both up and down, that’d be cool enough.
Pros and Cons of Going Long
- You actually own the stock, you may get dividends from that.
- Some types of stocks allow you to be part of shareholders’ meetings of a company.
- Limited loss – as much as you invest, that’s how much you can lose.
- If the stock falls your portfolio falls.
- Generally, you’d need money first to be able to buy stocks.
Pros and Cons of Going Short
- A way of profiting even when the market goes down.
- No ownership of the business.
- Limited revenue, unlimited loss – theoretically, stocks can go up forever, but it can only go down to 0.
- You need to open up a margin account first.
- There are fees needed when going short.
- Dividends paid by the shorted stock must be paid to the original stock owner.
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