Long vs. short trading explained
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For experienced traders, the direction of a trade matters as much as which financial instrument is being traded. Going long means positioning for a potential increase in price, whereas going short means taking a position based on an expected decline in price. But there’s more to unpack between these two approaches: understanding their differences is a key skill to acquire when one starts to enter and navigate financial markets.
What is a long position?
In the parlance of trading, an investor opens a long position when he or she buys an asset and holds it with an expectation that its price will go up, and will be able to sell it for a profit. A long trade doesn’t require a trader to buy and own the underlying asset. Sometimes, they can do it via derivatives like CFDs and futures contracts. Such instruments give traders an opportunity to open a long position without owning the underlying asset.
What is a short position?
Also called short-selling, a short position is a trading strategy used when a trader takes advantage of markets that are falling in price. Therefore, a short trade is when traders sell a borrowed asset in the hope that its price will go down, but with the plan to buy it back in the future for profit. It works by borrowing the asset from a broker and then selling it at the current market price.
Short positions can also be established through derivatives such as CFDs and futures contracts, without directly borrowing or owning the underlying asset. In these cases, the trader seeks to benefit from a decline in the price of the relevant instrument or underlying asset.
How long and short positions work
There are many reasons why an investor chooses either long or short positions. In other cases, they may establish both positions at the same time to leverage or earn income from a transaction. Let’s get down to the economics of it:
At its simplest, the distinction comes down to the direction in which you expect a market or financial instrument to move. Traders analyse an asset or market and form a view about its potential future price movement. If they expect the price to rise, they may take a long position. If they expect it to fall, they may take a short position.
The same basic principle applies across many financial markets. In the stock market, for example, a trader taking a long position generally expects the price of a share to rise. In forex, the trader is assessing the expected movement of one currency relative to another. Based on that assessment, they may choose to go long or short the relevant instrument.
Importantly, taking a long or short position does not mean knowing what the market will do. Financial markets are uncertain, and traders can only make decisions based on their analysis, expectations and assessment of risk.
The risks of taking short positions
Short positions can carry greater risk than long positions, particularly when a trader sells an asset short without a hedge. When a trader opens a traditional short position, they typically borrow the security, sell it at the current market price and later buy it back to return to the lender. If the price falls, the trader may profit from the difference. However, if the price rises, the trader will need to buy back the security at a higher price, resulting in a potential loss. Borrowing fees, commissions and other costs can also reduce any profit or increase a loss.
One of the key risks of an uncovered short position is that potential losses are theoretically unlimited. Unlike a long position, where the price of an asset cannot fall below zero, there is no theoretical ceiling on how high an asset's price can rise. As a result, the cost of closing a short position can continue to increase if the market moves against the trader.
Short selling and other leveraged positions are also subject to margin requirements. If the value of a position falls below the broker's required margin level, the trader may receive a margin call and be required to provide additional funds or reduce the position.
If the requirements are not met, the broker may close the position, potentially resulting in a loss. Traders should therefore understand the applicable margin requirements and have an appropriate risk-management plan before taking a short position.
Common pitfalls when taking long vs short positions
Recognising the following mistakes will help traders approach long vs short trading with patience and discipline:
- Relying on emotion: Choosing a direction emotionally can lead traders to commit to a position without sufficient analysis or a defined trading plan.
- Confusing market bias with evidence: Belief about a market falling or rising isn’t the same as observing the conditions that support either a short or a long position.
- Overtrading: When market direction is unclear, traders are tempted to switch back and forth between long and short positions. This practice only increases exposure to noise instead of meaningful movement.
- Using leverage to pursue larger returns: Increasing one’s leverage can also amplify the impact of adverse price movements. Case in point: a relatively small market move can have a significant effect on a leveraged position.
- Not accounting the costs: Spreads, commissions, and financing charges may have an effect on the overall result of a position.
Which is the best position to take?
The short answer is neither. Both positions are simply different ways of expressing a market view. It is better to ask whether the trade is supported by a defined rationale and appropriate analysis.Traders are encouraged to remain flexible, instead of becoming attached to a bullish or bearish view.
A thorough trading plan should establish the conditions for entering a specific position, the level at which the original idea is no longer valid and the amount of capital that can be reasonably placed at risk.
Think directionally, trade systematically with FP Markets
If you’re considering trading CFDs, take time to learn about leverage, margin, trading costs, as well as the risks involved before placing a position. At FP Markets, we provide a wealth of educational resources that will help sharpen your approach, and make sure your trading decisions are based on strategy instead of whim and emotion. When you’re ready, you can open an FP Markets trading account and access a broad range of global markets through leading trading platforms like MetaTrader 4, MetaTrader 5, cTrader, and others.
Frequently asked questions (FAQs)
A long position is taken when a trader expects an asset’s price to rise, while a short position is taken when a trader expects its price to fall. Long positions aim to benefit from upward price movements, whereas short positions aim to benefit from downward movements.
Short trading can carry greater risk because an asset’s price can theoretically continue rising without a fixed upper limit, potentially increasing losses on a short position. Leverage can further amplify both gains and losses, which makes effective risk management particularly important when trading short.
The decision should be based on your market analysis, trading strategy, risk tolerance and the conditions surrounding the asset you are trading. Rather than choosing a direction based on emotion or market bias alone, consider whether there is sufficient evidence to support the trade and establish your entry, exit and risk parameters before opening a position.
