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 speculating on price movements without owning the underlying asset. 

Investing = The act of buying an asset with the aim of making a profit when its value increases. 

What you should take from these definitions of trading vs. investing is that you can’t take long or short positions when you invest. 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. 

Trading doesn’t 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 possible when you invest. 

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 

You open a long trade by purchasing the asset. You download a trading platform and search through the assets you want to trade. The assets you can open long trades via contracts for difference (CFDs) include stocks, commodities, forex and indices. 

Buying, in this context, means you’re buying the price. Your goal is to hold the buy position until the asset’s value increases. Once it increases, you can sell and collect the profit. 

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. Therefore, the assets are listed in your account. So, if you open a long trade in oil, the barrels will be listed in your account. You don’t actually have to take delivery of barrels filled with oil. 

The point here is that the assets are listed in your account and the value of the trade is deducted from your balance. 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 allow you to profit when the value of the asset decreases. To make this possible, borrow the asset. The act of borrowing is, in a sense, theoretical. If you open a short position on oil, for example, you don’t have to collect the barrels. 

In practice, you’re borrowing the asset from a broker, i.e. they’re loaning it to you. You sell the asset you’ve borrowed at the current market rate. 

You now wait for its value to drop. If that happens, you buy it back for the lower price and give the asset back to the lender. The difference between the original value and the price you bought at is your profit. 

For example, let’s say you open a short position on Tesla stock when the price is $100. The price drops to $90 and you close your position, which means you’re buying at the new price point and returning the borrowed stock. 

The difference between the two exchange points is your profit. In this example, you opened the short trade at $100 and closed it at $90. The difference between the two points is $10, so that’s your profit. Certain costs and fees might be deducted from your profit. The difference in prices determines whether you make a profit or loss. 

If Tesla shares increased in value and you held a short position, you’d make a loss. Let’s say you opened the short trade at $100, waited, and closed the position at $110. 

In this example, you’ve actually paid more for the stock than you sold it for. That means you’ve incurred a loss equal to the difference in value, i.e. $100 - $110 = -$10. 

What does a short trade look like in your account? 

Continuing the example from above, going short on Tesla stock means you’ve borrowed and sold the stock (in theoretical terms). The money from the sale is credited to your account. You don’t get to use or withdraw this money because it’s not yours. Why? Because it’s the proceeds from the sale of the borrowed asset. Your account will also show that you have a negative balance of Tesla shares. 

When you close your short position, you replenish the negative balance of Tesla shares. The money you initially received for the stock gets paid off using the funds received when you closed the position. Anything that’s left over is yours to keep once costs and fees have been deducted. 

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 to the amount you paid to open the trade. 

This is because the value of an asset can only drop so much before trading activity gets restricted. In the US, this is known as the alternative uptick rule, and it’s used as a way of protecting the markets from potentially damaging movements. 

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 loss greater than 100% of your initial investment. 

One way to avoid this potential pitfall is stop-loss orders. A stop-loss limit allows you to set the amount of loss you incur before a trade is automatically closed. You set this limit before you open the trade. For example, if you set a stop-loss of 10%, the software will close the trade once your loss hits 10% of your initial investment. 

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 positions isn’t done for a long period of time, but it can be done if you think short-term market movements will hurt the current position you hold. 

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. This means you should never open long trades or short trades with money you can’t afford to lose. 

However, along with these risks come potential rewards. You can make money going long if the value of an asset increases. You can make money going short if the value of an asset decreases. These two things are always true. 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, you make the final call, but it’s advisable to assess technical indicators and other pieces of data before you do.