Updated on September 20th, 2019
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Often when listening to experienced stock traders discuss buying and selling stocks, many will say they are “long” or “short” a stock. This is just fancy terminology for whether the investor believes the stock price will increase or decrease. Long trades look to make money from the stock price increasing while short trades look to make money from the stock price decreasing. Long trades are often called being Bullish on a stock while short trades are often called being Bearish on a stock. This is just stock lingo, but we figured you should know it.
A long trade is simply just buying a stock. For instance, being “long” 100 shares of Wanda’s Bicycle Company means you have bought 100 shares with the intent to make money on the stock as the stock price increases. Since Wanda’s Bicycle Company’s stock can’t go any lower than $0, your maximum potential loss is 100% of your money but your potential profit is unlimited as the sky’s the limit for a stock’s price.
On the other hand, Short trades, also known as short selling, are trades that look to make money from the stock’s price decreasing. Short selling is a little more complicated than being long a stock. Because of this, an account with special requirements & borrowing privileges, called a margin account, is required to be able to short sell a stock. This is because an investor technically borrows the shares from the stock brokerage, immediately sells them, and attempts to buy back the same shares at a lower price with the intention on returning the borrowed shares and profiting the difference. This sounds complex but it happens instantly behind the scenes when you choose to short sell a stock.
Short selling can be riskier than buying a stock and is not recommended for inexperienced investors. This is because since you make money when a stock price falls and lose money when the stock price rises, potential gains are capped at 100% as a stock can go no lower than $0. But potential losses are technically unlimited as a stock price has no upper limit.
To explain using an example, if you short sold 1 share of Wanda’s Bicycle Company at $100 a share and the stock price increased to $200 a share, you have lost 100% of your investment. But if the stock continues to rise to $300 a share before you can buy the borrowed shares back, you now have lost 200%, meaning you have lost your original $100 investment and you owe your stock broker an additional $100. But if you are right on your prediction of Wanda’s Bicycle Company’s stock price and it decreases to $40 a share, you will profit $60 when you return the borrowed shares.
Ultimately, most investors should go long on companies they believe will rise in stock price in the future. History shows this has been a great strategy, especially in the United States. Going short stocks can also be profitable but you should remember this process has a little more risk.