Complete Explanation of Long and Short Positions in Crypto and Stock Trading
In stock, forex and crypto trading activities, of course a trader understands what a short position or shorting action is. Short position is one of the investment techniques, to exploit shares whose value is too high. Basically, you borrow stock from an investment company to sell it to other investors. Then, you have to return the shares you borrowed from the investment company.
The idea behind a short sale is to sell shares at a high price and buy new shares to give back to the investment company at a lower price, rather than having to sell borrowed shares.
For example, let's say a stock is trading at US$ 50 per share. You borrow 100 shares, and sell them for US$ 5,000. Then, the price suddenly dropped to US$ 25 per share, and at that time you bought 100 shares to replace the one you borrowed and made US$ 2,500.
What Are the Main Risks of Short Selling?
When you sell common stock, you are exposed to several types of risk. For that, let's explore a series of risks that you should know before considering short selling stocks.
Market Risk
Market risk is one of the biggest risks of short selling. There is no limit to how high a stock can go, so the market risk you face as a short seller is potentially unlimited. The higher the stock price, the more pain you will feel.
Short Squeeze Risk
Short squeezes can work against short sellers. A short squeeze occurs when many traders sell a stock (assuming that the stock price will go down), but the stock price goes up instead. One of the most famous short squeezes of all time occurred with GameStop Corporation (NYSE:GME) in early 2021, when retail investors surged GameStop's share price by more than 1,600% in fifteen days.
Is Short Selling Unlimited Risk?
The answer to that question is correct. When you conventionally invest in stocks, you can never lose more than your initial investment. However, you can lose an unlimited amount of money in a short sale, because the value of any asset can increase by an infinite amount.
What are the Advantages of Short Selling?
Of the advantages of short selling, the most obvious is that short selling can give you a profit without having to spend a lot of money up front. If you make the right decisions about stocks and the stock price drops, you will make money. This has the potential to be very profitable in certain stock market situations.
As long as you time your trades accurately it can turn into a profit. This sort of thing is easier said than done. Timing is also important in short selling, so you don't run into a downturn. Entering too early or too late can cause losses to occur.
Here are some examples of situations where short selling could potentially be profitable:
- During a bear market
- When market fundamentals deteriorate
- When technical indicators predict a bearish trend
- When the valuation reaches a high level
When you want to start short selling, consider carefully whether it is the right type of trading or investment option for you. Losses can be unlimited, because there is no limit to how high the stock price can go. Meanwhile, you also have to return the borrowed stock, but you may be forced to buy it back at a higher price, and that's when you can suffer a loss.
What is a long position in investing?
In investing, taking a long position involves buying a security (usually a stock), which you hope will increase in value over time. Oftentimes, it fits into an investment strategy known as passive investing or buy and hold because that's all you do.
Long lasting or 'Long', is what most people think of when they want to start investing. In fact, going long is the strategy of choice for most individual investors. Of course, it takes a little more effort to manage once you've selected and bought stock.
Profits From Long Positions
- Historically, stock markets and assets have been up in the long term. So, on average, taking long positions makes money. In fact, passive investment approaches have often outperformed more active investment approaches for decades.
- Holding on long tends to be lower risk than other strategies. Having a long term timeframe is definitely an average of the ups and downs in the market.
- If you buy and hold stock for at least one year, the tax you pay on any profits when you sell it will be lower.
Disadvantages of Long Positions
- Your money is tied up, perhaps for years.
- The longer you last, the more exposed you are to bad events, such as the company being sold or bankrupt.
- You could lose big if the bear market rages at your predetermined time to sell.
