When a trader enters a trade, they first need to take a position, between long and short. In brief, going long means buying an asset, whereas going short means selling an asset. Trading would be much simpler if it were that clear-cut, but there’s more to a long position and a short position. For instance, for short positions, a trader does not need to actually own any assets. They can instead borrow assets from a lender i.e., typically a broker or brokerage firm when deciding to go short (sell).
On the other hand, traders going long too don’t necessarily need to own physical assets but instead speculate on the price increase of underlying assets. This happens when a trader purchases a contract for a different (CFD) position in the hopes of profiting from the underlying asset’s value increase.
Put simply, when traders take on a long position, they buy assets which they predict will go up in value. So, going long is when traders buy an asset, intending to sell it later at a profit. However, when traders go short, they sell an asset they don’t own and which they foresee will drop in value only to buy it back at a lower price. After which, the asset is returned to the lender. Another way of looking at it is trading long equals buy low, sell high, and trading short equals sell high, buy low.
As can be seen, long trading and short trading with their many nuances create plenty of opportunities for trading profitably. Likewise, these nuances create the likelihood of great loss potential. Gaining more insight into trading strategies based on long and short positions will help in managing risks correctly.
Taking the Long Position
Long positions can be traded with multiple types of assets: stocks, currencies, options, futures, derivatives and more. Each asset has its own set of terms and conditions for a trader to base their trading strategies on. The differences can be in the type of ownership and contractual obligations between an investor and broker. One of the most common derivatives is a CFD in which a few kinds of underlying assets can be traded. Some examples of these assets are forex, commodities and shares.
In a long position, a trader can either buy an asset or a CFD. The latter is an agreement between an investor or trader and a CFD broker. CFDs allow an investor to gain from the price difference of an underlying asset from when the contract opens and closes. Therefore, an investor doesn’t make a purchase on the underlying asset. i.e., shares, stocks and etc but just bets on its price movement. If an investor goes long with a CFD position and the price movement changes in the investor’s favour, then they make a profit.
A more conventional trading investment is going long and holding on to security like a bond or a stock. Going long this way would make the investor the owner of the security purchased. This is an example of an investor purchasing a security with the expectation of an increase in its value and holding on to it for a bit. This type of long position would mean the investor is making a long-term investment and holding a bullish stance.
Taking a long position with a buy-and-wait approach on a bond or stock benefits an investor in a few ways. In the long run, market value increases allowing investors to earn a profit. As well as being relatively less stressful than when long trading short-term, the buy-and-wait approach is one way a long position can improve an investor’s chances of trading successfully.
Strategizing with Short Positions
An investor takes the short position or shorts an asset in order to make a profit. This is called short-selling. For example, an investor is interested in buying stock ‘PHI’ at $100 a share. The investor decides on buying 100 shares because he thinks it will be cheaper in the next week. For now, he pays his broker a small amount of margin deposit so he can borrow 100 shares of stock PHI. The margin deposit (usually around 20% of the full value) will undoubtedly be lower than the value of the stock which in this case is $100 x 100 = $10,000. Assuming the margin deposit is 20%, then the investor’s initial payment to his broker is $10,000 x 20% = $2,000.
Next, the investor immediately sells the 100 shares of stock PHI at the current market value of $100 and earns $10,000. Then, a week later, true to his predictions, stock PHI drops in price to $70 a share. He buys it back at that rate and his spending now is, $70 x 100 = $7,000. Now, he can return 100 shares of stock PHI to his broker. Based on this example, the investor makes a profit: -$2,000 + ($10,000 – $7,000) = $1,000.
Financial Market Example: Forex
In forex, when a forex trader goes long they would be buying the base currency and selling the quote currency. For instance, when they trade in the USD/JPY pair, then going long would mean they are buying USD and selling JPY.
Shorting a trade in the forex market would be the opposite. Investors trading the USD/JPY pair, go for a short position when they sell the base currency and buy the quote currency. In this case, they would be selling USD and buying JPY.
When to Use Long and Short Positions
- Bullish Market
In a bullish market, when a market is showing an uptrend, is when an investor goes long on an asset. The consensus among investors who opt to go long on a stock is that the stock they have purchased and own will increase in value. Due to this being the main intent behind taking a long position, investors normally use the long position for when the market is bullish or on an uptrend. This is especially so when past data show that the bullish market trend will be protracted. - Bearish Market
When the market is headed towards a downturn and is looking bearish, traders tend to place short position orders. This can be taken as a loss-cutting measure or when a trader wants to cut their losses. Another reason a trader might want to go short on a stock is to make a profit. However, short selling benefits a trader in making profits more for short-term trading because assets normally depreciate in value more frequently than appreciate.
The Connection: Calls, Puts, Long and Short
- Call – A call is an options contract or financial contract that gives a trader (options buyer) the choice to buy an asset. This contract gives the trader the right but not the obligation to buy the asset. Additionally, the contract states that the asset should be bought at a set time within a specified time period. The asset. i.e., bond, commodity, or stock for the call option is termed as the underlying asset.
- Put – Similarly, the asset for a put option is known as the underlying asset. Here, the financial contract gives a trader the right to sell assets, with no obligation. The seller also buys the assets at a fixed price and within a certain timeframe.
The connections between the four: calls, puts, long and short can be found in many trading strategies, but one example is the Long Straddle. This is when an investor wishes to execute long and short positions at the same time on the same underlying asset. This is a risky move but is taken by experienced investors to turn a profit on their investment. For those wishing to hedge their bets, they place a long call position, and at the same time, they open a long put option on the asset. This way, with the strike price and expiration time locked in the investor can act accordingly when market conditions are right.
It is important to keep in mind, that a long straddle strategy is used when an investor is certain about an asset’s market direction either moving significantly upwards or downwards. Their sentiments in this case are usually brought about by newsworthy events or a piece of headline news. So, with a long straddle, whichever direction the market moves, the investor expects to make a significant profit. On the flip side, this is a risky move due to the higher costs involved in placing both calls and put options simultaneously and if the market does not make a strong movement in either direction.
Another way an investor could profit from using the Long Straddle is by taking a measure of a market’s implied volatility, a metric conveying the probability that an asset’s price will change based on the market view. Investors refer to implied volatility to predict market direction, price action, and supply and demand. With increasing implied volatility generally comes an increase of both puts’ and calls’ values at all exercise prices or strike prices. With both call and put options in hand, an investor should be able to profit if they close their positions before the implied volatility reaches its highest.
The Long and Short of Trading
Both long and short positions create opportunities for wins and losses. Although with short positions, more is said of its riskiness. As asset value moves downwards faster and increases gradually, a short position is one that requires more precision and caution from traders. Notwithstanding, a long position also has its disadvantages due to the longer holding time needed for an investment to turn profitable. With a longer holding time of an asset, a trader’s funds are held up by the investment, and their investment is more exposed to risk.
Aside from understanding the basic concepts of long positions and short positions, any investor or trader would benefit from learning more about position management and planning. It is a form of risk management and more information can be obtained from the educational tools provided by a brokerage firm. ZFX Academy offers great tips on position management and planning here.
FAQs
- What is a long and short position in trading?
Going long means buying an asset, whereas going short means selling an asset. When traders take on a long position, they buy assets which they predict will go up in value. So, going long is when traders buy an asset, intending to sell it later at a profit. However, when traders go short, they sell an asset they don’t own and which they foresee will drop in value only to buy it back at a lower price. After which, the asset is returned to the lender. - What is an example of a short position?
Short selling: For example, an investor is interested in buying stock ‘PHI’ at $100 a share. The investor decides on buying 100 shares because he thinks it will be cheaper in the next week. For now, he pays his broker a small amount of margin deposit so he can borrow 100 shares of stock PHI. The margin deposit will undoubtedly be lower than the value of the stock (usually around 20% of the full value) which in this case is $100 x 100 = $10,000. Assuming the margin deposit is 20%, then the investor’s initial payment to his broker is $10,000 x 20% = $2,000. - What is long vs short in forex?
In forex, when a forex trader goes long they would be buying the base currency and selling the quote currency.
Shorting a trade in the forex market would be the opposite. Investors trading the USD/JPY pair, go for a short position when they sell the base currency and buy the quote currency. - How do you know when to trade short?
Bearish Market — When the market is headed towards a downturn and is looking bearish, traders tend to place short position orders. This can be taken as a loss-cutting measure or when a trader wants to cut their losses. Another reason a trader might want to go short on a stock is to make a profit. However, short selling benefits a trader in making profits more for short-term trading because assets normally depreciate in value more frequently than appreciate.
