What is a Long Position?
When you buy a security with an expectation that its price will rise in the future, you have a long position in that security. You can take a long position in various kinds of securities, such as shares, bonds, mutual funds, derivatives, foreign exchange, etc.
Typically, when you go long on an asset, you do not intend to sell it in the near future. This is because you expect its price to increase in the future and you intend to hold it until its price increases. When the price finally increases, then you can choose to sell it.
A long position is the most conventional type of position because traditionally people invest in a security hoping that its price will increase, which will allow them to sell it to earn a profit. Having understood what a long position is, let us talk about what a short position is.
Additional Read: Call and Put Options: Meaning, Types & Examples
What is a Short Position?
When you sell a security without actually owning it, you are deemed to have taken a short position on it. You may wonder why you would sell anything without owning it. When you expect a security’s price to fall in the near future, you can sell it today with an intention to buy it in the future when its price would have fallen.
By doing this, you would have sold the security at a high price and bought it back at a low price, thereby earning a profit.
That said, in India, naked short-selling is not allowed. In naked short selling, you do not borrow the security you want to sell. Hence, you can keep on selling a security without either borrowing it or owning it, which can create extreme downward pressure on its price and can be manipulative.
Hence, in India, you have to first borrow the securities that you want to short. You borrow those shares whose price you expect to decline. You can short-sell in India only on an intraday basis. This means that you can borrow a stock anytime in a day to short it, but you will have to buy it back before the stock market closes that day.
Key Differences Between Long Position vs. Short Position
The key differences between a long position and a short position are explained in the table below:
Long Position
| Short Position
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When you take a long position in a security, you buy it.
| When you take a short position in a security, you sell it without owning it. However, to sell it, you have to borrow it.
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You go long on a security because you expect its price to rise. If its price rises, you can sell it to earn a profit.
| You short a security because you expect its price to fall. When its price falls, you can buy it at a lower price to give it back to the person from whom you borrowed it to sell it in the first place.
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A long position is meant for everyone. Even the most risk-averse person has bought some asset or security sometime in his life with the hope that its price will rise in the future, which will allow him to earn a profit.
| A short position is meant mostly for experienced and aggressive traders, who have been following the market for a long time and who understand its pulse. Besides, in the Indian context, a short position has to be squared off within the same day. Hence, unless you have the ability to make a decision quickly, you should not short a security.
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Having learnt the differences between a long position vs. a short position, let us take examples to understand them better.
Features of Long and Short Position (need to add content in a listicle format)
Examples of Long and Short Position
Let us take an example of a long position first. Suppose you think that Tata Steel’s price will go up in the future and hence you buy it at around Rs. 152.05 (its closing price on September 20, 2024), you will be deemed to have taken a long position on it.
In a long position, you do not intend to sell a security very soon. However, it depends upon an investor as to how long he intends to hold it. Let us say that a month from now, Tata Steel’s price moves up to Rs. 160 and you think you have made sufficient profit on it. Hence, you can sell it. But, another investor expects the price to move further up; hence, he may hold it for a longer period than you.
Let us take the same example of Tata Steel to explain a short position. Suppose it is September 23, 2024, and Tata Steel’s price is around Rs. 155. You expect its price to fall before the market closes on September 23. Hence, you borrow it and short it at Rs. 155.
You will have to square off this position before the market closes on September 23. Hence, you will have to buy Tata Steel no matter what its price is before the market closes on September 23. If its price falls, you will gain; however, you will lose if its price increases.
Impact of Long Position and Short Position on Financial Markets
When a significant number of investors take a long position on a security, its price usually increases, as it shows that the investors have faith that this security will help them earn a profit in the future.
Similarly, when many investors take a long position on a financial market, it is good for that market because it reflects that the general investor sentiment is positive towards the market.
When a considerable number of investors short a security, it typically creates downward pressure on its price because this shows that most people think its price will decline in the near future.
Similarly, when many investors start shorting a financial market, it creates pressure on that market, resulting in a significant decline in the prices of many securities listed over there. Hence, it is seen to be negative because it shows that investors are losing faith in that market.
Pros and Cons of Long Position and Short Position
Pros of a long position
Scope for profit: If the price of a security in which you have a long position increases, you will earn a profit.
Ownership: When you have a long position in a stock, you have voting rights in that company. Hence, you can exercise your voice regarding the workings of that company to the extent of your stock ownership.
Passive income: A long position in a stock can help you earn passive income in the form of dividends.
Cons of a long position
Possibility of a loss: If the price of a stock in which you have a long position falls, you may end up incurring a loss.
Market volatility can give you stress: A long position usually involves an investor holding a stock for a long time. But, he will have to bear with market volatility which can cause the price of the stock to rise or fall, which can cause him stress.
Additional Read: Difference Between Demat and Trading Account
Pros of a short position
Quick returns: When a short position is executed well, it can help a trader earn a quick return. In India, a short position must be squared-off on the same day it was initiated. Hence, a trader can make a profit on the same day on which he had taken a position.
Use leverage to your advantage: In India, you have to borrow a stock to sell it. Hence, you can use leverage to your advantage while shorting a stock. In other words, you do not have to block your own funds here.
Cons of a short position
Probable loss: When you short a stock, you will earn a loss if its price increases later. This is because you will have to buy it at a higher price than you had sold it to return it to the person from whom you borrowed it.
Can be extremely stressful: As a short position has to be squared off on an intraday basis, it can be extremely stressful for a trader especially when the security which he has sold witnesses an increase in its price.
Conclusion
If you are about to open a demat account, you should get a grip on the merits and demerits of a long position vs. a short position. While it is not difficult to understand the benefits and drawbacks of these positions, you must carefully learn how and when to take a long position and a short position because only then you will become a successful investor.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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