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Buy and sell the concept in trading.
The stock market or forex market has various terms attached to it; one such term is long trades vs. short trades. But what does that mean, and how do they affect how a trader executes his/her traders? Well, read this article to know more.
Short and long in trading
The concept is easy: buy long and sell short
The Buy and Sell concept in trading is the same as long and short trading. When you go long on a trade, it means you are buying that stock; when you sell a stock, you are shorting the stock. The purpose of going long is to buy at a lower price and sell at a higher price in the future, whereas going short has the purpose of selling the stock first at a high price and repurchasing it when the price falls.
Long Trade Orders
As a trader, if you have taken a long trade order, it means you have already bought the stock and are waiting to short it when the price soars. Long and buy are the same options, though many times, some trading software gives long instead of buy options. Even traders use this terminology by using words like, “I am thinking of going long on Microsoft.”
Let us take an example here; Grey is a stock market trader and is thinking of going long on a stock named ABC, which is trading at $25 right now. He buys 100 shares, which costs him $2500. Now, if he goes short on this trade at $26, he would gain $2600 on his trade, while his profit would be $100 excluding the commission and fees.
For long trades, the potential to profit is higher if it has been done in the bull market, which means you can buy a stock for $5, and it can get to any price, whether it’s $500, $1000, and so on. Though day traders do not get such high prices as they trade for tiny time frames, as a long term investor, you can certainly get benefits of such high prices.
The picture is not all rosy, as if the prices fall, you will make losses. Now taking the previous example of Grey, if his stock price falls to $23, he will lose $200 excluding commissions. In severe market conditions, prices can go down to $0, which would make you lose your entire trade. But that’s why stop losses are important to have in place while trading.
Short Trade Orders
Compared to long trading, short trading can be a bit tricky to understand for novice traders. However, nothing is challenging to understand. Going short on trade means you are selling that stock. Traders sell the stock first here, with a view that the prices would go down, and when the prices fall, traders repurchase the stock to close your trading position.
Long or short – it is the question. Recently we wrote an article about long trades vs. short.
Just like giving long options while trading, many software writes short instead of selling. Even traders use terminology such as “I am thinking of going short on Facebook.” Short selling allows traders to sell what they don’t have.
Let us understand this with an example. Emmy is a stock market trader and thinking of going short on a stock ABC. She shorts 500 shares at $20, which means she has taken the trade of $1000. She believes the price will go down, and when it falls, she buys the stock at $17. In the end, she earns a profit of $1500, excluding any commission to be paid.
Though in short trading, there is a downside risk if the prices soar. If this stock price increases to $23, instead of making $1500, Sasa will lose $1500. The more the prices increase, the more the loss would be.
The maximum profit a trader can make by short selling is until a stock’s price reaches 0. At the same time, the maximum loss is unlimited as prices can increase to any extent. You can lose more than the initial amount you invested; you can lose $1000 on a trade value of $500. That’s the reason that day traders put stop loss so that they can save themselves from such terrible situations.
In short, selling, for you to sell shares that you do not own, your broker has to borrow the shares from someone else in the market; without that, you cannot take a short position in the market. Also, note that the stocks that have just been listed through IPOs (Initial Public Offering) can not be shorted as they have just started on the stock market.
In short selling, professional traders only care about the moving market and not the directions of moving prices, and thus regardless of whether the market is going up or down, they tend to gain profit. That’s the beauty of the stock market.
The Bottom Line
Trades can buy long and sell short in various financial markets, including the stock market, commodity market, forex market, etc. Though in the futures market and forex market, short selling is prevalent, with most traders taking short positions. There are many stocks in the stock market as well, which earn more profit while having a short position than a long position.
If the short-selling continues in a bear market, or when the prices of a stock are slumping down due to some major events, it can practically make a company insolvent with the stock price potential reaching $0. To prevent this from happening, and by taking lessons from the global financial crisis of 2008, the Securities and Exchange Commission (SEC) in the United States in 2010 levied the alternative uptick rule. The rule restricts short selling if the stock price drops 10 percent or beyond 10 percent in a day so that the bloodbath can be stopped.
This was the practice in Europe too. For example, in Europe in the spring of 2020. there was a COVID virus crisis in Italy and Spain. Stocks from Italy and Spain went down a lot. Short selling was prohibited for Italian and Spanish stocks.
So, whether you go long on the market or short on the market, as a trader, you have to be cautious as the market is very dynamic, and you must possess the skills and knowledge required to dive into it. The best thing you can do is educate yourself through various studies and research material available on the market and keep yourself updated with the latest trends by reading the news. Remember, the more you work hard, the more fruits you would bear later.