What Does Long and Short Mean in Investing?
“Long” and “short” are fundamental terms used frequently in financial news, market analysis, and financial conversations. No matter what kind of investor you are — day trader, retail investor, accredited investor, or someone simply interested in the markets — understanding these terms can be helpful on your journey.
Long positions refer to the way most of us invest in the stock market — it means you own the stock and will profit if the share price rises. This is the most straightforward way to trade equities.
For example, an investor who owns 100 shares of XYZ company stock in their portfolio is said to be long 100 shares. This investor has paid the full cost of owning the shares.
Going short on a stock means an investor has a negative position in the stock, meaning they have sold stock they do not own. You may be familiar with this phrase from the 2015 blockbuster “The Big Short,” which refers to the investment practice of shorting.
There are multiple methods to go about short sales, but essentially shorting a stock means you borrow the asset, sell it, then buy it back cheaper in order to earn a profit. These traders will sell the unowned stock at a high price and wait to buy it back once the share price has (hopefully) fallen.
How Does Short Selling Work?
A short sale is the sale of a stock that an investor does not own or a sale which is fulfilled by the delivery of a stock borrowed by, or for the account of, the investor.
Oftentimes, the short investor borrows the shares from a brokerage firm in a margin account to make the delivery. Then, with hopes that the stock price will fall, the investor buys the shares at a lower price to pay back the dealer who loaned them.
Short sales are typically settled by the delivery of a security borrowed by or on behalf of the investor. The investor later closes out the position by returning the borrowed security to the stock lender, typically by purchasing securities on the open market.
Short selling on margin is also used by market makers and others to provide liquidity in response to unanticipated demand or to hedge the risk of an economic long position in the same security or related security. Hedge funds are some of the most common short sellers, day traders have recently noticed this trend and attempted to win big on stocks that are over-shorted by institutions — this method has led to the rise of meme stocks.
Investors who sell stock short tend to do so because they believe the price of the stock will fall, hoping to buy the stock at a lower price to make a profit. If the price of the stock rises, short sellers who buy it at a higher price will incur a loss.
Brokerage firms typically lend stock to customers who engage in short sales, using the firm’s own inventory, the margin account of another of the firm’s customers, or another lender. The equities held by the customer are often used as collateral for these trades.
As with buying stock on margin, short sellers are subject to the margin rules and other fees and charges may apply (including interest on the stock loan).
If the borrowed stock pays a dividend, the short seller is responsible for paying the dividend to the person or firm making the loan.
Example of Margin Trading
For example, if you short 100 shares of ABC stock at $20, you’ll first sell them and receive $2,000 in your trading account. Your portfolio will show negative 100 shares. The negative share balance must be brought back to zero at some point by purchasing back the shares.
Later, if the stock price has fallen, you can buy back 100 shares at $15 per share at the total cost of $1,500. Since you initially received $2,000, buying back the shares for $1,500 gives you a $500 profit.
However, if the price had instead increased to $25, you would lose $500 because you had to buy back the shares for $2,500.
Short selling can also refer to buying put options contracts. Options contracts give investors the right, but not the obligation, to buy or sell a security (or other asset) at a specific price by a set date.
Options trade on the public exchange with their price affected by the value of the underlying security. Options contracts will specify the underlying stock, the strike price (the price at which you can buy the underlying stock), the premium (price of the option), and the expiration date.
While there are multiple types of options and a variety of ways to trade options, for the purpose of explaining short selling put options are the most relevant. A put option allows the owner of the contract to sell the underlying asset at the pre-determined strike price up until the option’s expiration date.
Example of Put Option
Options are quoted in the price per share of stock, rather than the price to own an actual contract. For example, the last quoted price on an option may be $1.25. To buy that contract, it would cost 100 shares per contract x $1.25 = $125.
A put option may be sold as “ABC January 50 Put $2.25” which means the owner (or buyer) of this contract has the option of selling ABC stock at $50 a share any time before the expiration date in January for the premium of $2.25.
If an investor purchased this put option in November when the stock is trading at $55, they believe the price of the stock will fall. The total price of this contract is $2.25 x 100 = $225. If the share price falls to $50 or below, the option owner could either exercise the option or could trade the options contract on the open market as the premium would rise along with the decline in stock price.
If the stock price rises instead, the owner of the put option would likely choose to let the option expire, meaning they lost the initial premium but nothing more.
This is one of the most basic forms of options trading, many options contracts and the trading strategies that utilize them are much more complex.
When Can You Short Stocks?
In the futures and forex (foreign exchange) market, investors can short at any time. However, in the stock market there are more restrictions on which stocks can be shorted and when.
“Long” and “Short” in Other Contexts
Being long, or buying, is also a phrase used by investors to describe their sentiment on a security, industry, or asset class. “Bullish,” “bull,” and “long” are often used interchangeably. A trader who says “I am long XYZ stock” or “I’m bullish on XYZ” is saying the same thing, they believe prices will rise.
Investors who are “short” a company or industry can also be called “bearish,” meaning they believe the stock is overvalued, or will drop in price. Someone bearish about a company may short the stock, or they may just use that terminology to describe their view.
These phrases can describe either the investment decision to trade, or can simply describe an investor’s sentiment.
While “long” and “short” both refer to methods of trading stocks, they also refer to investor sentiment on a company, index, or asset class. “Bullish,” “long,” and “overweight” are all synonyms that mean an investor believes the asset’s value will rise. “Bearish,” “short,” and “underweight” all indicate that an investor believes the asset’s value will fall.
This material is provided for informational and educational purposes only. It is not intended to be investment advice and should not be relied on to form the basis of an investment decision