Being "long" in the stock market doesn't mean you've been there forever, and being "short" doesn't mean you're at a height disadvantage compared with other traders. "Long" and "short" refer to whether you've staked your money on a stock's price rising or falling.
When you're in a long position in a stock, you've bought it expecting the price to go up. In a long position, you run the risk of the stock price falling, in which case your investment will lose money. But your risk is limited to the amount you've invested. Buy $1,000 worth of stock and the most you can lose is $1,000. Most people in the stock market are in a long position.
To establish a long position, you simply buy shares of stock and wait for the price to rise. Once it does, you have a decision to make. Your gain exists only on paper until you convert it to cash by selling the shares. Wall Street calls this "profit taking." You can sell and take your profit, skipping the chance to make more money if the price rises further. The other option is to hold the shares in anticipation of greater profits, risking that the price will fall and wipe out your gain.
In a short position, you're doing just the opposite: You've got your money riding on the price of particular stock falling. "Going short" is considerably more complicated than going long. First, you borrow some shares of the stock from your broker. Next, you sell those shares on the open market at the market price.
Let's say you sell that borrowed stock for $10 a share. Then you wait for the stock price to fall. When it does, you go back into the market and buy up the same number of shares you sold before. Say you buy them for $8 a share. Finally, you return those shares to your broker. This is called "covering your short." Your broker gets back to where he started and collects interest from you while you use the shares, and you've made a profit of $2 a share.
Shorting a stock carries potentially catastrophic risks if the price rises instead of falls, so if you're going short, you'd better know what you're doing. Say you sold your borrowed shares for $10 and the price rises to $11 a share. Covering your short will leave you with a loss of $1 a share. If the stock really goes nuts and jumps to $20, your loss has been magnified to $10 a share. In theory, there's no limit to how much you can lose. "Short sellers" stuck in this decision have to decide whether to cover at a loss and forgo the chance to profit if the stock falls back down, or hold off on covering in the hope that the stock will go back down, risking even greater losses.
- Spencer Platt/Getty Images News/Getty Images
- Tradable Stock Options
- Conservative Option Strategies
- What Happens to Stock Price When Short Interest Evaporates?
- How to Short Sell the Japanese Stock Market
- Long Position vs. Short Position
- 5 Reason Stocks Drop and Rise So Much
- How to Calculate the Percentage Return on Investment If You Bought Stock on Margin
- How Do Short Sales on the Stock Market Work?