Have you ever been confused when someone says that they’re going long or short on a particular stock? Or you didn’t understand what the news reporters meant when they say that the FIIs or DIIs have created a short position? What does long and short mean in the terms of the stock market? Long and short are just fancy stock market terms which new investors and traders find confusing but they are very easy to understand.
Long position means that you are bullish on a stock or an index. If you have a long position in Reliance Industries, it means that you are expecting that the price of the stock will increase and you plan on capitalizing on this price rise by either buying the stock directly or trading in futures/options for Reliance Industries.
On the other hand, a short position means that you are bearish on a stock or an index. If you have a short position in Reliance Industries, it means that you are expecting that the price of the stock will decrease and you plan on capitalizing on this price fall by either selling the stock directly or trading in futures/options for Reliance Industries.
This means that every long term investor who likes to hold the stocks for a long period of time stays in a long position. If you have been holding a stock for a few years, then you have been in a long position for years! Markets tend to be bullish over the long term, so being in a long position for the long term makes a lot of sense. However, over a short term there can be corrections or crashes which give traders and investors an opportunity to short the market i.e. make money in a falling market.
There are three main ways to take a long or short position in the stock market.
1. Buying or selling stocks
This is the simplest way in which you can go long or go short in the stock market. Suppose you are bullish on TCS stock. You buy the stock for Rs. 3200 and sell it for Rs. 3250 the same day. You just took a trade in the long position by being bullish on TCS and made Rs. 50 per stock!
Profit = Sell Price – Buy Price = Rs. 3250 – Rs. 3200 = Rs. 50
Suppose you are bearish on ITC stock. You sell the stock for Rs. 230 and buy it back for Rs. 200. You just took a trade in the short position by being bearish on ITC and made Rs. 30 per stock!
Profit = Sell Price – Buy Price = Rs. 230 – Rs. 200 = Rs. 30
Notice that in both cases, the profit remains sell price – buy price. Only the order in which you buy or sell changes in a long or short position when trading stocks.
Going long might seem easy but how does going short work? Can I sell a stock without even owning it? The answer is YES! You can sell a stock first and then later buy it back which is called trading in a short position. Notice that a short position will only make you money if the price of the stock falls. If you sell something for cheap and buy it back later for more money, then you will lose money in a short position!
One major difference between going short or long is the time duration. You can take a long position for as many days as you want. If you buy a stock and hold it forever, then you are in a long position forever. If you want to know whether you should hold a stock forever, visit this article.
But you cannot short a stock forever because it is not allowed. If you are shorting a stock by selling the share, then it has to be squared off intraday which means that the sold share needs to be bought back on the same day. But can I short stocks for a duration longer than 1 trading day? This brings us to the other ways of taking a long or short position in the stock market.
2. Buying or selling options
Options are financial derivatives which get their value based on the underlying asset. Simply put, these are financial contracts which get traded in the stock market based on the value of the stock/index to which the options belong. If you want to learn how options work in the stock market, visit this article!
Options provide a way for investors and traders to go long or short in the stock market. Let’s suppose that you want to go long on Reliance Industries. Then instead of directly buying the share, you can either buy a CALL option or sell a PUT option for Reliance industries. This will create a long position on Reliance Industries and you will make money if the price of the stock goes up.
On the other hand, if you want to short Reliance Industries then instead of directly selling the stock you can either buy a PUT option for Reliance or sell a CALL option for reliance. This will create a short position on Reliance Industries and you will make money if the price of the stock goes down.
There are some benefits of shorting the market using options. Short positions can be held for durations longer than intraday. All options expire on their expiry day (which is generally the last Thursday of the month unless there are any holidays). On the other hand, shorting the stock by selling it directly requires the stock to be squared off on the same day by buying it back. Options can be held until the day of the expiry or even squared off intraday which can make them a lot more flexible than shorting stocks directly. Another benefit is that index cannot be shorted directly because Index is not a stock which can be directly bought or sold! The only way to short the index is using Futures or Options.
Despite its benefits, the biggest problem with options is the huge volatility which it experiences. The fact that options expire on the expiry date also requires the trader or investor to be extremely active in the market and should NOT be used by passive investors. Options can only be traded in a lot unlike a stock trading which has no such limitations. E.g. if a share has a lot size of 1000, then an option can be traded for 1000 shares or its multiple and there is no flexibility to trade any stocks less than 1000! A trader or investor needs to be extremely skilled before attempting options trading.
3. Buying or selling futures
Futures are financial derivatives (similar to options) which get their value from the underlying asset. Futures are similar to options which can be traded in the stock market and have an expiry date on which the contract gets squared off. Unlike stocks, it is NOT required to buy back any futures which are shorted by the trader on the same day and can be held until the date of the expiry. This gives investors and traders a way to create short positions in the stock market for a longer duration.
However, there are some key differences between stocks and futures which investors need to be aware of! Futures can only be purchased in a lot. So if a stock has a lot size of 1000, then the futures (or options) have to traded for the entire lot size of 1000. This doesn’t apply to stocks because any number of stocks can be bought or sold as per the wish of the investor or trader. Futures also have the option of leverage which can make the entire transaction much more profitable or loss making than buying or selling stocks directly. This can be risky for retail investors or traders who are not completely aware of futures!
So the long or short position can be created using three options – stocks, options and futures. My recommendation for new investors and traders would be to stay away from futures and options until they are very comfortable with stock trading and investing.
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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