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.
Similarly, some trading software has a trade entry button marked "buy," while others have 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.
Long Trade Potential
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 XYZ 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 is the desired result when going long.
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.
The flip-side to an increase in price is a decrease. If you sell your shares at $9.90, you receive $9,900 back on your $10,000 trade. You lose $100, plus commission costs.
The largest loss possible in this example is if the share price drops to $0, resulting in a $1 loss per share. Day traders work to keep risk and profits under tight control, typically exacting profits from multiple small moves to avoid large price drops.
Shorting a stock is confusing to most new traders since in the real world we typically have to buy something to sell it. 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 pay is lower than the price they sold for. In the financial markets, you can buy and then sell, or sell and 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 (trying to sell what they don't have).
Short Trade Potential
Similar to the example of going long, if you go short on 1,000 shares of XYZ 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 the profit or loss of your position is.
If you can buy the shares at $9.60, you will pay $9,600 for the 1,000 shares. 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. Your risk, though, is unlimited since the price could rise to $10, $50, or more. The latter scenario means you would need to pay $5,000 to buy back the shares, losing $4,500. Since day traders work to manage risk on all trades, this scenario isn't typically a concern for day traders that take short positions (hopefully).
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 (able to be sold, and then bought) in the stock market as well, but not all of them.
In 2010, the SEC imposed the alternative uptick rule, which restricts short selling from further driving down the price of a stock that has dropped 10% or more in one day.
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.