Long Position vs Short Position: Key Things You Need to Know

Whenever you place a trade in any segment of the financial markets, you either buy an instrument or sell one. This fundamental difference gives rise to two types of trades — namely long trades and short trades. Often, beginners come across the terms ‘long’ and ‘short’ in the context of trading and may find themselves confused about these words. If you too have been in a similar situation, this article can make the long position vs short position concept clearer for you. 

Let us begin by discussing what each position entails and then delve into the long vs short position comparison. 

What is a Long Position?

A long position involves buying a stock or security and taking delivery of the instrument. This type of position is generally suitable when you expect that the price of the instrument purchased will rise in the future. So, you buy it (or take a long position) and expect to sell it later for a higher price. A long position is typically best suited for a bullish market or a market that has just turned bullish after a bear run.

What is a Short Position?

A short position is the opposite of a long position. Here, you sell a stock or security that you do not currently own. Instead, you borrow it from your stockbroker. Then, when you want to close the short trade, you need to actually buy the securities in the market and repay the broker. The setup of this trade indicates that a short position works best in a falling or bearish market — where you can sell high and later buy low. 

Long Positions vs Short Positions: A Broad Comparison

Broadly, the long position vs short position comparison reveals that these two types of trades are fundamentally different in many ways. Typically, long trades are easier to understand because they involve simple transactions where you pay money to buy a stock or security, hold it and then sell it for money on the exchange. 

However, short trades may be harder to understand. Since you do not own the asset when you sell it, these trades require a margin deposit. This is not the case with long positions, where you need to pay the cost of the securities upfront. 

The margin deposit acts as collateral to cover potential losses because short selling involves borrowing the asset to sell it. If the asset's price rises instead of falls, the broker may request additional funds through a margin call to maintain the position. This added layer of complexity and risk makes short positions more challenging for many traders.

Additionally, whether you are trading in the equity cash segment or the derivatives segment, the question of taking a long vs short position is always relevant. To make an informed choice, you need to know how these two types of trades work. An example can help bring more clarity. 

An Example of Long Positions vs Short Positions

Let's say that you believe that the price of a particular stock, currently trading at Rs. 500, will increase. You decide to take a long position by purchasing 10 shares and paying a total of Rs. 5,000 for the trade. Say the price of the stock rises as expected and reaches Rs. 550 per share, at which point the trend starts to show signs of weakening. So, you can sell your shares for Rs. 550 each (or for Rs. 5,500 in total) and earn a profit of Rs. 500.

On the other hand, if you expect the stock price to drop, you might take a short position. This means you borrow 10 shares at Rs. 500 from your stockbroker and sell them in the market at that price, earning Rs. 5,000. If the price falls to Rs. 480 within the same trading day, you can buy back the 10 shares for Rs. 480 each or Rs. 4,800 in total and return them to your broker, pocketing the difference of Rs. 200. However, if the price rises instead, your losses could mount, as you’ll need to repurchase the shares at a higher price.

Long Positions vs Short Positions: The Key Differences

To understand the long trade vs short trade discussion better, let us delve into the many differences between the two. 

• Trade Direction

A long position benefits from an increase in the asset price. You buy an asset expecting its value to increase. Conversely, a short position benefits from falling prices. You sell an asset you do not own, hoping to buy it back cheaper. 

• Market Sentiment

The market sentiment driving long positions vs short positions also differs. You make long trades in bullish markets, where investor sentiment is optimistic, and prices are expected to rise. Short positions, however, are common in bearish markets with a pessimistic outlook.

• Profit Potential

In a long position, the profit is theoretically unlimited because prices can rise indefinitely. In a short position, however, the gains are capped because prices can only drop till zero. However, the losses in short trades are potentially unlimited if the price soars. 

• Risk Exposure

The risk profile of long positions vs short positions is also starkly different. In long trades, the risk is limited to the amount used to buy the stock or security. If the price falls to zero, you lose the investment amount. Short positions, however, carry much higher risk. 

• Cost Considerations

When you hold long positions, you do not incur any significant costs. Typically, the expenses are limited to transaction fees in these trades. Short positions, however, can be more expensive because of the margin requirements involved. 

• Time Horizon

You can hold long positions over different time frames — ranging from a few minutes or hours to several days, months or years. However, short positions are much more short-term. Additionally, in the equity cash segment, only intraday short trades are allowed. 

• Market Impact

Long positions support price rises because the demand for the stock or security drives its price up. On the other hand, short positions create downward pressure on the prices, especially if large-scale short-selling occurs in the market. 

Long vs Short Position: Can You Combine the Two?

It does not always have to be an issue of long positions vs short positions. You can combine both types of trades through various strategies like pairs trading or hedging. In pairs trading, you place a long trade using one stock or security and a short trade using another correlated stock or security. These two opposing positions are generally taken simultaneously or within the same time frame, so you can benefit from the relative performance of the stocks. 

Hedging, on the other hand, involves taking an opposite position in the same instrument or a related instrument, so you can limit your overall losses. For instance, you could hedge a long position in a stock by taking a short position in a call option. 

Also Read: Benefits of Holding Stocks for the Long Term

Conclusion

Understanding long vs short positions is crucial for making informed trading decisions. Each has its own set of risks, rewards and strategic applications, depending on the market conditions. Long positions are straightforward and suitable for bullish markets. Short positions, though more complex, allow you to profit from declining prices.

To navigate these strategies effectively, it is essential to have access to robust research tools. Motilal Oswal's Research 360 platform can offer you these tools. With comprehensive insights and analytics to help you make well-informed decisions, whether they are going long or short, this platform can significantly improve the way you trade. Having these resources at your disposal also allows you to manage risks better and optimize your trading outcomes.