During the existence of the stock market, investors have developed many trading strategies. But almost each strategy applies one of two ways of making a profit on the price difference
What is a long position?
Long position is one of the most popular trading strategies on the stock market.
Its mechanism is the easiest to understand, which is why newcomers to the stock market usually start with it. Investors turn to this trading method when they expect growth in quotations. The purpose of the long position is to buy stocks when they are cheap and sell them when they are up.
An investor opens a long position when he buys a stock. As long as the investor holds the stock, the investor is said to be “holding a long position.”
When an investor sells a stock, he or she closes the long position. The profit is derived as the difference between the purchase and sale prices.
The position is called long because it can be held indefinitely. By taking a long position, you can make a profit, even if you invest for a long time – at least a year.
In the long term, the securities market is growing. A single stock can theoretically appreciate indefinitely. So you don’t have to worry about price fluctuations in the short term. Even if the stock falls in price, it will recover in a few years and probably grow, even more, bringing profit to the owner.
What is a short position?
An investor opens a short position, hoping to profit from a fall in the market prices.
To do so, he borrows shares from a broker against cash, sells them on the market, and waits for them to fall in price. The investor is then expected to buy the same number of shares at a lower price and return them to the broker. The difference between the selling price and the buying price is retained by the investor as profit.
Unlike the long position, a short position can only be opened for a short period. This is due to the fact that the investor must return the securities that he lent, and not for free, to the broker.
Short selling is not the sale of shares from the investor’s portfolio. When an investor sells securities purchased earlier, it is merely the closing of a long position.
Traders also refer to a short position as a short. Shorts also open, hold, and close. An investor who plays short is known as a shorting (emphasis on the last syllable). Until the investor buys the stock and closes the position, he is said to be “short” or “shorting.
Why a short position is riskier than a long one
Exchange experts do not recommend novice traders to trade on borrowed funds because it is a very risky strategy. The risk is that the share price may rise contrary to expectations.
And the investor finds himself in a difficult situation. He has to return the borrowed securities to the broker, and in order to do that, he has to buy them at a higher price than he was selling them before.
If you have decided to try to earn on short selling, it is better to be secured. Exchange experts advise making sure to place stop-losses and not to borrow too much.
When lending stock to a trader, a broker also risks much. This is why brokerage companies impose restrictions for those wishing to make money on falling stocks. Investors are allowed to open short positions only on the most liquid stocks on the market. A complete list of such securities can be found on the broker’s website.
The broker also introduces special ratios. With their help, he determines the amount that should lie on the client’s brokerage account before opening a short position. This amount exceeds the aggregate value of the borrowed shares. It is necessary for the client to be able to cover their value if the market suddenly begins to rise instead of falling.
In case of such developments, the broker also sets a price, upon reaching which the trader or the broker can forcibly close the position. This occurs if the broker sees that the money the investor has pledged may not be enough to repurchase the shares.
Short selling strategy may be resorted to by market manipulators. These are usually large investors who have enough money to steer the market in the direction they want. That is why the shorting game is monitored by special commissions. In the USA, these are the SEC or Commission on Securities and Exchange.
How short and long positions affect the market
Investors who prefer to go long are called upside investors. And here’s why: if there are more investors who believe the market will continue to rise and go long, the market goes up. The same is true for individual companies.
Similarly, a strategy based on opening short positions is called a bearish play, and the traders themselves are called bearish players. Accordingly, if the market is dominated by downside players, the market declines.
But if the market accumulates too many long positions, then the so-called overhang is formed, and it becomes more likely that market participants will start to close positions en masse, that is sell shares. And it can lead to the collapse of the quotes.
The same is true for short positions. If there are too many short positions, any news item can trigger massive buybacks. In doing so, stock indices (or stock prices) literally skyrocket in short order.