When it comes to stocks, you either go short or you go long, and we’re not talking about heights or distances. The terms short and long are referring to whether a trade was initiated by buying first or selling first.
The difference between the two comes into play in what the trader is trying to accomplish. Are you as the trader expecting to sell at a higher price and make a profit or are you intending to repurchase the stock at a lower price and make a profit?
Either way, the end goal is to profit but the journey to how you get there is different.
To understand the difference between these two trade tactics, you have to be able to define them and break them down into their basic concepts. So, let’s define going long first. A long trade is, as stated above when a trader purchases an asset and waits to sell that asset at a higher price than initially bought. The terms buy and long are used interchangeably in this process, so it’s easy to get confused when you’re having it explained to you. In a similar sense, some trading software will use a button that has the word “buy” on it, while other software will use a button marked “long”. The term long is often used to describe an open position.
For instance, saying “I am long Microsoft” would mean that you currently own shares of Microsoft.
To extend this definition, let’s talk about “going long”. When a trader says that they are “going long” or are going to “go long”, what they mean is that they are expressing interest in purchasing a particular asset.
If a trader goes long on, let’s say, 1,000 shares of an asset at $10 a share, that transaction would cost them $10,000. If they luck out and are able to sell those shares at $10.20 a share, they’ll receive $10,200. That would make their profit $200, not counting commissions. In a situation where a trader is going long, this would be the ideal outcome.
A trader’s profit potential is unlimited, due to the price of an asset being able to rise indefinitely. Therefore, if you buy 100 shares of a stock at $1, the price of that stock could potentially rise to $50 or $100 if you luck out in terms of stock trajectory.
Though, that’s not something that happens often, so keep in mind that most traders end up trading for smaller moves. The potential is there, it’s just not very likely and it’s best to manage expectations.
Now on the flip side, instead of an increase in price you could run into the opposite. A decrease in price means a loss in profit and a loss in profit means that you’re not doing so well in terms of growth. Say you sell your shares at $9.90 in comparison to the $10 that you bought those shares for. You receive $9,900 instead of the $10,200 that we saw in the earlier example. Instead of the profit coming out to $200 there would be a loss of $100, plus the commission costs. Always remember to factor in commission costs.
The real catastrophe comes in when there’s the possibility that the price of the share can drop down to $0, meaning that you’re losing $1 a share. Though $1 doesn’t seem like a big loss, remember that in the earlier example the trader had bought 1,000 shares. When you’re working with that much in assets, $1 starts to stack up and now you stand to lose a lot of money. As a trader, your daily task is to manage risk v. reward and keep tight control of your profits. This typically involves exacting profits from small moves to avoid large price drops.
Let’s move on to short trades. Shorting a stock can be very confusing for first time traders. This comes down to the difference in how real-world transactions usually happen. You see, typically you would have to buy something to sell it. This is different from how short trading works, in that traders who short sell are selling these assets before buying them and are hoping that the price of these stocks goes down before then.
As a trader, you realize your profit when the price you sell a share for is higher than the price that you pay for that particular stock. In financial markets, you can buy and then sell, or you can sell and then buy. The point is that once the transaction is done, you make a profit.
In the world of trading, the terms “sell” and “short” can be used interchangeably. Just as we say with long trading, some trading software can have a trade button marked “sell”, while other trading software can have a button marked “short”.
The term “short” can also be used to describe an open position. So like in the earlier example, if a trader says, “I am short Microsoft” that would mean that they have a short position in Microsoft. You’ll often hear traders say that they “going short” or “go short” to indicate their intention in shorting a particular asset: aka selling an asset before they own it.
So say you go short of 1,000 shares of stock at $10 a share, you would receive $10,000 into your account, however, this isn’t your money yet. It only becomes your money once you buy those shares that you sold. Your account will show that you are -1,000 shares and that will only balance out to 0 when you buy those shares. You won’t know the actual profit or loss that you come out with until then.
That little bit of mystery is where the danger comes in.
If you can buy shares at $9.60 a share, you’ll pay $9,600 for 1,000 shares. In your sale, you sold those 1,000 shares for $10,000, bringing your profit to $400, minus commissions. Now, as mentioned before the mystery of how a stock will rise or fall can affect your profit. If the price of those stocks rise and you repurchase those shares at $10.20, you’ll be coming out of pocket $10,200 for those shares. That’ll mean that you lost $200, plus commissions.
Whereas your profit potential in going long is essentially limitless, the opposite can be said when it comes to shorting. In shorting, your profit is limited to and dictated by you amount you initially received in your sale.
In fact while your profit is limited, the risk is in fact unlimited and that’s why it’s advised not to go short on a stock if your a first time or rather new trader. Not only are you not very experienced but you may not have the backup funds to cover any losses.
But now that you know the risks and how to differentiate a short and a long, you can make the informed decision on if these two tactics are right for you.