In-depth Analysis

Long trading vs Short trading

If you want to take advantage of the financial markets with leveraged products like CFD (short for  Contracts For Difference) through scalping, day trading, or other trading styles, you can either bet on a rising price movement (long position) or a falling price movement (short position).

It all comes down to what you think an asset price will do next.

When you begin your trading journey, some terms may be confusing and it sometimes takes time to fully understand what they mean. If you’re not sure about the meaning of long or short positions, don’t worry! We will explain everything in this article.

Understand long trading

Definition

Long trading, or “going/being long” refers to long positions opened to take advantage of bullish market conditions.

With long or buy positions, you buy an asset and hold it to sell later at a higher price to make a profit with the price difference (minus trading fees).

Example

Because of increasing inflation and rising interest rates, you decide to bet on financial stocks. So, you open a long position on 1 Bank of America share at $40 with a target price of $45 and a stop-loss at $38.

If the stock goes up and touches the $45 level, you will be up $5 ($45-$40). If the stock goes down to $38, you will be down $2 ($40-$38).

Note: In our example, we used 1 contract, but with CFDs you can use margin trading to increase your market exposure. The profit and loss (P&L) you computed is for 1 contract only. So to get your final P&L, you will have to multiply it by the number of contracts.

Pros

  • As the stock market has historically been one of the profitable investment vehicles over time despite all the crashes and bear markets, long positions have the highest probability to make money over time.
  • Opening long positions is often considered a less risky strategy, especially in the long run.
  • The risk of loss is limited in the sense that an asset can only go to 0.
  • With long positions, you can either own the asset if you trade without leverage or not own the underlying asset if you use leverage and derivatives.

Cons

  • If you invest over the medium to long-term, your money is tied up.
  • Your long positions are exposed to short-term risks and volatility.
  • If you need to get out of your positions during a bear market, you could lose big.

Understand short trading

Definition

Short trading, also known as short selling, or “going/being short” is the opposite of long trading. When you open a short or sell position, you’re therefore expecting the asset price to drop.

To take advantage of this fall, you will borrow the asset from your broker, sell it on the markets and wait for the price to fall enough to buy it back at a lower price, returning it to your broker while keeping the difference in price (minus the brokerage fees).

Example

If you think that growth stocks will fall because of rising interest rates in the United States and new monetary policy, you might want to short sell these types of stocks to benefit from a fall in their share prices. So, you open a short position on 1 Amazon share at $3,090 and spot a key level at around $2,800.

If the stock goes down and touches the $2,800 level, you will be up $290 ($3,090-$2,800) and you will close your position.

Let’s say you applied a 1:2 risk/reward ratio and set up a stop-loss at $3,235. If the stock goes up, you will be losing money. If the Amazon stock goes up to $3,235, your protective order will be triggered, and you will have lost $145 ($3,090-$3,235).

Note: Remember that if you open more than 1 contract, you’ll have to multiply your P&L by the number of contracts to get your final P&L.

Pros

  • Short selling is a great way to make money during bearish markets.
  • It is also a good option for hedging your portfolio when fundamentals worsen.
  • Associated with long positions, short positions can reduce your portfolio’s overall volatility and risk.
  • Short trading is always made through margin and leverage accounts, which means that you do not own the underlying asset and that you can take advantage of more market exposure.

Cons

  • You are exposed to various risks, such as regulatory risk, short squeeze risk, and margin risk.
  • The fall might just be temporary if it is a pause in a bullish trend – your timing must be right if you don’t want to lose big.
  • The potential loss is unlimited, as an asset can rise to theoretically any amount.
  • Short selling is only available in conjunction with margin trading, meaning you’ll be paying fees that aren’t applicable to long-trading if you’re not using margin.
  • Short sales are sometimes limited if the price of an asset drops by a certain percentage too quickly.
  • If you short sell a stock and the company pays a dividend, you’re responsible for paying it.

How to choose between long trading and short trading

While long positions are used in trading to take advantage of upward price movements, short positions are used to profit from downward price movements. The choice between the direction of your trade depends on how you’re trading and where you believe the market will go next.

There are several ways you can forecast price movements. Technical analysis, fundamental analysis, and sentiment analysis are the 3 types of market analysis used to analyze the markets to decide whether to open a long or a short position.

Technical analysis uses price action, chart patterns, and technical indicators to anticipate a market move. There are 3 assumptions associated with technical trading – 1) prices always move in trend, 2) history repeats itself, and 3) prices integrate all available information.

Contrary to technical analysis, fundamental analysis ignores all technical aspects and focuses on the fundamentals that help determine the intrinsic value of an asset and compare it to market prices to see if an asset is over/under valued. If you trade the stock market, you might be interested in two popular approaches: Bottom-up vs. Top-down.

The role of sentiment analysis shouldn’t be underestimated while trading, as it can provide tools to better understand the attitude and the mood of investors towards specific financial instruments. With sentiment analysis, it is all about how emotions and cognitive and psychological biases influence the markets.

Important Note: With ActivTrades, you can open long and short positions with margin trading accounts. If you want to be able to open a long and a short position on an asset at the same time (also known as “hedging”), you need to activate the “hedging” feature in the “Order Handling Mode” option in your online personal area under the “Accounts” tab “My Account” section.

Read our previous article to get a few ideas about how to best manage volatility and risk when trading to better protect your trading capital.

 

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