The Difference Between Long and Short Trades
When it comes to stock market trading, the terms long and short refer to whether a trade was initiated by buying first or selling first. A long trade is initiated by purchasing with the expectation to sell at a higher price in the future and realize a profit. A short trade is initiated by selling, before buying, with the intent to repurchase the stock at a lower price and realize a profit.
Day traders often will use the terms "buy" and "long" interchangeably. Similarly, some trading software has a trade entry button marked "buy," while others trade entry buttons marked "long." The term often is used to describe an open position, as in "l am long Apple," which indicates the trader currently owns shares of Apple Inc. (AAPL).
Traders often say they are "going long" or "go long" to indicate their interest in buying a particular asset. If you go long on 1,000 shares of XYZX stock at $10, the transaction costs you $10,000. If you are able to sell the shares at $10.20, you will receive $10,200, and net a $200 profit, minus commissions. This type of scenario is preferred when going long. The alternative is that the stock drops. If you sell your shares at $9.90, you receive $9,900 back on your $10,000 trade. You lose $100, plus commission costs.
When you go long, your profit potential is unlimited since the price of the asset can rise indefinitely. If you buy 100 shares of stock at $1, that stock could go to $2, $5, $50, $100, etc., although day traders typically trade for much smaller moves. Your risk is limited to the stock going to zero. In the example above, the largest loss possible is if the share price goes to $0, resulting in a $1 loss per share. Day traders keep risk and profits well controlled, typically exacting profits from multiple small moves.
Day traders in short trades sell assets before buying them and are hoping the price will go down. They realize a profit if the price they buy it for is lower than the price they sold it at. Shorting a stock is confusing to most new traders since in the real world we typically have to buy something to sell it. In the financial markets, you can buy and then sell or sell then buy.
Day traders often use the terms "sell" and "short" interchangeably. Similarly, some trading software has a trade entry button marked "sell," while others have a trade entry button marked "short." The term short often is used to describe an open position, as in "I am short SPY," which indicates the trader currently has a short position in S&P 500 (SPY) ETF. Traders often say I am "going short" or "go short" to indicate their interest in shorting a particular asset.
Similar to the example of going long, if you go short on 1,000 shares of XYZX stock at $10, you receive $10,000 into your account, but this isn't your money yet. Your account will show that you have -1,000 shares, and at some point, you must bring that balance back to zero by buying at least 1,000 shares. Until you do so, you do not know what your profit or loss on your position is.
If you can buy the shares at $9.60, you will pay $9,600 for the 1,000 shares, but you originally received $10,000 when you first went short, so your profit is $400, minus commissions. If the stock price rises and you repurchase the shares at $10.20, you pay $10,200 for those 1,000 shares and you lose $200, plus commissions.
When you go short, your profit is limited to the amount you initially received on the sale. For example, if you sell 100 shares at $5, your maximum profit is $500 if the stock goes to a price of $0. Your risk, though, is unlimited since the price could rise to $10 or $50, or more. The latter scenario means you would need to pay $5,000 to buy back the shares, losing $4,500. Since risk management is used on all trades, this scenario isn't typically a concern for day traders that take short positions.
Shorting, or selling short, allows professional traders to profit regardless of whether the market is moving up or down, which is why professional traders usually only care that the market is moving, not which direction it is moving.
Shorting Various Markets
Traders can go short in most financial markets. In the futures and forex markets, a trader always can go short. Most stocks are shortable in the stock market as well, but not all of them. To go short in the stock market, your broker must borrow the shares from someone who owns the shares, and if the broker can't borrow the shares for you, he won't let you short the stock. Stocks that just started trading on the exchange—called Initial Public Offering stocks (IPOs)—also aren't shortable.