What is long and short trading?

Trading vs. investing

Let’s quickly talk about trading vs. investing before diving into long and short trades. We offer trading and investment options for a variety of financial instruments at Saxo Bank. Trading is one way to buy and sell financial instruments, but it’s not the only one. Investing is the other side of the coin. It's like trading, but it’s not entirely the same. Understanding the difference between trading and investing is important regarding going long and short.

Trading = The act of buying and selling financial instruments over shorter time horizons. Some trading involves derivatives where you don’t own the underlying asset.

Investing = The act of buying and holding assets, often over longer time horizons, with returns coming from price changes and/or income (for example, dividends or interest).

You can be ‘long’ an asset by owning it. Taking a short position typically involves using a product or mechanism that allows short selling (for example, stock borrowing, derivatives, or certain funds), and isn’t available in all accounts or jurisdictions. Buying the underlying asset means you own it and, just as it would be if you owned property, your fortunes are directly linked to its value. If the asset’s value increases from the point you invested, you’ll make a profit. If it decreases, you’ll lose money.

Some types of trading do not require you to purchase the underlying asset. This means you can speculate on its price movements. Having the ability to trade against price movements, instead of owning the underlying asset, means you can go long or short.

You can make long trades when you think the price will increase. You can make short trades when you think the price will decrease. That’s not usually possible when you simply buy and hold the underlying asset.

Defining long and short trades

We’ve given you a general overview of trading and how you can go long or short. To recap, going long is when you believe the value of an asset will increase. Going short is when you believe the value will decrease.

These are simple concepts to grasp. The question though, is how do you open long trades and short trades?

How to open a long position

Through a trading platform, you can open long or short positions using different instruments (including CFDs, where available), across markets such as shares, indices, forex and commodities.

In this context, you are opening a position that may benefit if the price rises. Your goal is to hold the buy position until the asset’s value increases. If the price increases and you close the position above your entry level, you may make a profit after costs.

The asset’s value won’t always increase which means you won’t always make a profit on long trades. The same is true for short trades. Nothing is guaranteed in trading. However, when you open a buy position, you’re doing this intending to sell once the asset’s value has increased.

What does a long trade look like in your account?

Taking a long position means you’re buying the asset. What a long position looks like in your account depends on the product. If you buy the underlying asset, it will typically appear as a holding in your account. For derivatives such as CFDs, your account typically shows a position in the instrument (not ownership of physical barrels).

If you buy the underlying asset, the holding typically appears in your account and the purchase value is reflected in your cash balance. Margin and derivative positions may appear differently. This contrasts with the way short trades are shown on your account, as we’ve explained in the next section.

How to open a short position

Short positions can allow you to profit if an asset’s value falls, although losses are possible if the price rises. How a short position works depends on the product. In physical share short-selling, this typically involves borrowing shares from a broker and selling them at the current market price. If the price falls, you may be able to buy the shares back at a lower price, return them to the lender, and keep the difference as profit before costs and fees. With derivatives such as CFDs, the mechanics are different, and you typically take a short position without owning or borrowing the underlying asset.

For example, let’s say you open a physical share short position on Tesla stock when the price is $100. If the price falls to $90 and you close your position, you buy the shares back at the lower price and return them to the lender. In this example, the difference is $10 per share, which would be your profit before costs and fees.

If Tesla shares rise in value instead and you hold a short position, you would make a loss. For example, if you open the short trade at $100 and close the position at $110, you would incur a loss of $10 per share, excluding any additional costs and fees.

What does a short trade look like in your account?

Continuing the physical share short-selling example above, you have borrowed and sold the stock. How a short position appears in your account depends on the product, account type and market. In physical share short-selling, sale proceeds and the borrowed position are typically reflected in the account, but those amounts may be subject to restrictions and margin requirements.

When you close that physical share short position, the borrowed shares are returned and your account is adjusted accordingly. Any profit or loss will depend on the difference between the opening and closing prices, after costs, fees and any applicable financing or borrowing charges.

Caution: Short trades have limited potential but unlimited risk

Going short can be a good move if the market conditions are right. However, if you’re going to make short trades, you need to understand that your potential profit is limited because the asset price cannot fall below zero.

Short-selling rules can vary by market and may restrict short selling in certain conditions (for example, after sharp declines).

What’s not limited, however, is the potential downside. The price of an asset isn’t subject to any limits. This means you could open a short position and the value of the asset could go on a major bull run. If the price increases too much, you may be forced to close the position at a large loss and, depending on the product and leverage used, losses can exceed your initial outlay.

One way to help manage this risk is by using a stop-loss order. A stop-loss order lets you set a price level at which an order to close your position is triggered. You set this before you open the trade. A stop-loss order can help limit losses, but in fast-moving markets it may execute at a worse price than expected due to gaps or slippage. If you set a stop-loss at a level equivalent to a 10% loss, an order to close the trade will usually be triggered when that level is reached, but the execution price may be worse than expected.

Should you go long or short in trading?

Going long or short depends on a variety of factors, including your personal trading preferences and market conditions. Only you know whether you prefer long trades or short trades. Assessing market conditions requires you to read the latest financial news, look at tips from experts, and carry out various forms of analysis, including technical analysis and fundamental analysis.

Sometimes the indicators suggest a long position is best. There may be times when a short position is best. There may even be times when taking both positions is useful. Holding long and short positions at the same time is known as hedging.

You’re using one position to counteract the other during times of high volatility. Hedging can be short-term or longer-term, depending on the objective.

The bottom line here is that trading gives you the ability to go long or short on financial instruments. The decision on which position you take at any point in time is yours. It’s important to understand that you may not make a profit.

Trading carries a certain amount of risk, and the value of an asset can increase or decrease. It’s generally important to understand the risks and only trade with money you can afford to lose.

However, along with these risks come potential rewards.  A long position may benefit if the price rises and a short position may benefit if the price falls, but trading costs, execution and market moves mean profits are not guaranteed. The thing you need to work out is which position you should take based on the current market dynamics.

That’s where the art and science of trading come into play. We have a variety of resources on Saxo Bank to help you assess the markets and make decisions. Ultimately, decisions depend on your approach, and many traders use a combination of analysis tools and market information.