Long vs. Short Position: A Breakdown of Stock Positions

Key Points

• In a long position, an investor purchases and holds shares of stock they think will increase in value long-term. The investor holds and sells the shares, seeing a profit or loss corresponding to changes in value. 
• In a short position, an investor borrows shares from their broker and sells them at the current market price. The investor then repurchases the shares at a later time and returns them to the broker, with the intention to pay a lower price later on. 
• "Shorting" a stock creates the possibility of unlimited losses, which it is not a strategy reccomended for beginners. 

Many new investors are surprised to learn that it’s possible to financially benefit from both a bear and bull market. Long and short positions can be used in conjunction to benefit from multiple economic climates and introduce a unique level of opportunity to an otherwise stabilized portfolio. 

The primary difference between long and short positions is the direction in which the investor believes the underlying stock price will move. In a long position, the investor purchases and holds the shares, benefiting from long-term increases in share price and benefits like dividends. In a short position, an investor borrows and sells shares at the current market price, aiming to buy them back at a lower price and return them when the price per share falls. 

Long Positions: Benefits and Risks

The phrases “going long” and “taking a long position” both refer to an investor’s long-term belief that a stock will rise in price. To complement this opportunistic outlook, the investor purchases shares and subsequently owns a portion of the company. If the stock rises in value, the investor can sell their shares or otherwise benefit from price increases. The most important thing to remember about long positions is that when an investor is long, they own the underlying stock.

Benefits of Long Positions

Long positions are usually recommended for beginner investors and those looking for a “set it and forget it” option for wealth growth. This type of position’s more simple nature and options for long-term gains make them suitable for more types of investors. 

• Own the underlying investment: In a long position, the investor owns shares of the underlying investment, resulting in potential profits from a long-term rise in value.
• You cannot lose more than 100% of your initial investment: In a worst-case scenario, a long position can only reach a value of $0. It’s not possible to lose more money than you originally spent entering your position. 
• Chance to profit from dividends: Because you own the underlying stock, you’ll be entitled to a portion of any dividend payments offered to investors. Risks of Long Positions

Risks of Long Positions

While long positions are usually considered less risky than short positions, they still come with the risk of significant market fluctuation and loss. 

• Risk of price fluctuations: No stock can guarantee any type of positive returns. Long positions can come with significant price fluctuations and even the result of long-term loss. 
• Opportunity cost: Holding a long position ties up capital that could be used for other investments or opportunities. If a better investment opportunity arises, you could miss out on the opportunity to purchase shares. 

Short Positions: Benefits and Risks

Taking a short position allows you to benefit when a stock declines in price. Short strategies use more complicated financial instruments to access potentially unlimited gains (and losses) depending on how the underlying stock changes in value. Unlike long positions, short investors do not own the shares they trade on — part of the reason why this strategy is riskier. 

How Short Selling Works

In the short-selling strategy, an investor begins by borrowing shares of stock through their brokerage firm. They sell the shares at the current market price, indicating their belief that the stock will decrease in value over time, and promise to return the shares at a high price. The investor then waits for the price per share to drop and later purchases the shares again at a lower price. 

The profit from the trade is related to the difference in price between the purchase and sale price of the shares, with higher profits being realized if the stock decreases more in value. However, understanding short selling isn’t as simple as a single calculation. To short a stock, you’ll need to apply for a margin account through your broker, which comes with additional interest fees when you borrow shares to complete your trade. You also don’t own the underlying investment during the shorting period like when you go long on a stock, meaning that you can’t access dividend and retirement account tax benefits. 

Benefits of Short Positions

Investors who correctly predict that the market will soon decline can potentially profit from an environment in which most investors are seeing losses. 

• High profit potential: Investors who sell their shares before the price of a stock suddenly dips can realize unlimited potential profits through short selling. 

• Faster turnover: Unlike long positions, short positions typically close in a matter of days or weeks. This frees up your initial trading capital for future trades. 
• More active investment strategy: For investors who prefer to take a more direct approach to their investing strategy, shorting may be a viable option.

Risks of Short Selling

Attempting to time the market is never recommended, especially for beginners. The inherent nature of borrowing shorts from your broker means that losses from short selling can be sudden and significant. 

• Potential for unlimited losses: Unlike when going long, shorting a stock can result in a loss of more money than you initially invested. You’ll always need to return shares to your broker, no matter how the price moves after purchase. 
• Requires a margin account: Shorting requires approval and funding for a margin account, which not all investors may be able to access. Margin accounts also come with additional fees, as you’re essentially borrowing the shares with interest for the period before you return them to your broker. 

Investing Strategy: When to Go Long or Short

The decision whether to take a long vs short position  on a stock involves more than your opinion on its potential; the best investment strategy will also vary depending on your goals and risk tolerance as well. 

Market Analysis and Timing

Look at the news and examine what experts are saying about the condition of the economic climate and potential future developments. If you believe that an industry or stock is likely to increase in value over time, it can make sense to go long. If you believe the stock will soon see a dip in value, short selling can create opportunities. However, it’s important not to put too much emphasis on attempting to “time the market,” as unforeseen events can quickly reverse trends and expert predictions. 

Investor's Risk Tolerance and Goals

Your individual risk tolerance also influences the best type of investments to include in your portfolio. If you’re like most investors, you likely want to take a lower risk, long-term approach to investing for a major goal like retirement. In these circumstances, it makes the most sense to invest more conservatively, using long positions to generate wealth over time. Fewer transactions and long positions also result in less ongoing maintenance expenses on your account, which can result in additional streams of revenue. 

If you’re taking a short-term timeline to investing for a goal other than retirement, shorting might be a better route toward your goals. This can be especially true if you’re an experienced investor looking to short a few select stocks that you’ve traded in before. Be sure to review company leadership goals and financials before shorting to limit loss potential. 

Portfolio Diversification

Diversification is an important concept in investing that helps limit losses in changing economic climates. To diversify, it’s important to invest in a series of asset types, companies and sectors. Short positions can be used to introduce a unique level of opportunity to an otherwise stabilized portfolio made up primarily of long-term holds. This allows you to benefit from riskier positions while also limiting losses if your predictions aren’t correct. 

Make Informed Investments with MarketBeat

If you believe a stock’s price will rise in value, you may want to take a long position by purchasing and holding shares. Short positions can be used (with caution) to benefit from declining share prices potentially. Both types of positions can both have an important place in a well diversified portfolio, with long positions making up the majority of investments for risk tolerance reasons.