Everyone is familiar with the expressions “take a long position” and “take a short position.” The last strategy gave the name to one of the best films about investments and trading – “ The game for a fall ”. Today we will examine the mechanism of opening long and short positions on the example of the stock market. Let us find out how it works in practice and whether it is worthwhile for a novice investor to short the stock.
What is The Difference Between Long and Short on The Stock Market?
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Long ( English. Long – long ) reflects the long-term strategy for trading stocks. As a rule, it is based on fundamental indicators and is designed for a “buy and hold” position, a gradual increase in the market value and regular receipt of dividends . Such players earning in a growing market are conventionally called “bulls”. In periods of economic growth, they dominate, and it is accepted to call such a market “bullish”.
The opposite strategy comes from the word “short” ( English Short ) and reflects a speculative position, designed for quick profit not on a gradual growth, but on a rapid fall. All stock market indices are growing in the long term: according to statistics, 80% of the time, markets go up. However, crises and falling prices of individual stocks happen sharply and unexpectedly for most investors. The downward movement of the graphics is almost always shorter and sharper. In order not to lose, but to make a profit on a landslide drop in quotations, a strategy has been devised for short-term asset purchase and its subsequent sale with profit. Players for a fall are called “ bears ”. In contrast to the “bulls”, they earn in a falling market, which is typical of the financial crisis or problems with one individual company.
I will describe the difference at the maximum available level. The “long” deal is explained simply: buy low – sell high, the difference in your pocket. A “short” deal means: to take a loan is expensive – to repay a loan cheaply, the difference in your pocket, minus the fee for using the loan.
Short requires the use of leverage , because in order to sell something “unnecessary”, this “something” must first be bought. The difference with the classic loan is that the broker lends not money, but securities with leverage, the size of which depends on the risks of a particular stock. Accordingly, the short increases the cost of an error when taking the wrong position. Credit for opening a long position is used less frequently.
It is important to make a reservation: not all shares can be short. This is associated with significant risks of such operations and the inability to quickly sell assets. Due to the risks of high volatility and low liquidity, the broker may not allow opening a short position on the shares of the second and especially the third echelon . Issuers, even with a large capitalization, but recently passed an IPO, also can not be short. Stock statistics are not enough for them, and the behavior of their shares may be unpredictable. Only a small list of highly liquid stocks, mainly blue chips – Gazprom, Sber, Rosneft, etc., is available to open short positions for securities. A list of so-called collateral assets can be found on your broker’s website.
Usually shares available for margin trading are divided into Russian and foreign securities. The latter are intended for qualified investors. Within each of these categories there is a division according to the client’s risk levels — standard, elevated, and high (special). Each broker has its own classification details, but all of them are subject to the general requirements of the Central Bank , the exchange and the clearing organization.
In addition to reservations on the list of securities, brokers introduce a number of restrictions that insure a deal against large losses:
- Discounting factors – the share of equity at the opening of a short position (as a down payment on a mortgage);
- Mandatory stops in the trader’s terminal;
- The level of quotations at which the broker forcibly closes short positions (margin count).
How a Short Position Trade works
The “short” trading algorithm is mirrored in relation to the structure of the “long” transaction, that is, the opposite is built:
- A trader borrows shares from a broker when their value is high;
- Sells an asset and waits for a price reduction (Sell Short order);
- Redeems at a price less than the perfect sale;
- Returns the depreciated shares to the broker (order Close Short);
- He takes the difference to himself, minus the brokerage commission.
In fact, a trader sells papers that he does not have in stock. Therefore, such a transaction has another name – “sale without coverage.” So that the trader does not withdraw funds from the sale of securities, they are blocked on the brokerage account until the borrowed shares are returned.
Technically, everything happens simply – a few clicks in the terminal. However, in order to make a profit on such an operation, the trader must foresee the price movement down, otherwise he will be at a loss. In addition to losses from an incorrectly occupied position, the trader will also pay a commission for each day of using the borrowed asset, including weekends. Within one trading day, no credit is charged, the transaction is sometimes carried out without transferring a short overnight position.
If the broker can move the position the next day, it will cost you money. The fee is calculated as a percentage per annum and is repelled from the current key rate . Often the profit from the difference in the price of buying and selling shares is comparable to the size of the commission. To these costs is added the standard commission on turnover (depending on your tariff plan). That is, being in a short position for too long, the trader risks giving the broker all the profits from the operation. It is for this reason that such positions are short, and they close as quickly as possible.
Example: you borrow Rusal shares (RUAL) from your broker for 32 rubles. April 4, 2018, sell them and get real money on the account. After 10 days, buy the same stock for 19.8 rubles. and give them to the broker. There is a difference on the account with which the intermediary will take a commission for 10 days of using credit shares (annual rate / 365 * 10).
Now we take into account the nuances, without which the scheme of the transaction “short” will be incomplete. The broker gives a loan not only for a fee, but also with collateral with the same shares, but already in your portfolio. Suppose you have 10,000 shares of Rusal, that is, your depot is equal to 320,000 rubles. The broker gives a loan in the amount of 95% of the depot – 9,500 shares for 304 thousand. You are selling these virtual papers. You return the stock to the broker, the price of which is already 188,000 (198,000 * 95%) that day. The difference before the commission is deducted will be 116 thousand rubles. Of course, the ideal case is described here, at the maximum price amplitude.
In practice, things are more complicated. The cost difference is rarely more than 10%, and the limit provided is not always fully utilized. In addition, the broker also has its own clearing limits on the stock exchange, over which he will not be able to lend the paper you need. Then the position will not be transferred overnight, and the broker will be forced to close or transfer it partially.
Another mandatory element of the transaction is the stops that the trader exposes for himself in the terminal. They will work if the price moves upward instead of falling and reaches the established percentage of the original. Also, there is always a margin call on the part of the broker, because he risks non-return of the loan. When a client’s own funds become less than the amount of debt, the broker first sends the demand for additional deposit or cash. At the next set level, he forcibly closes the position (if the stop-loss did not work before). This usually happens when the price goes up against the occupied position by more than a third. Then the broker himself buys on the stock exchange the lent you growing shares and thereby closes his loss. Since your position is closed at this moment, you cannot do anything with your own losses. Margin stake is rarely used, only during periods of abnormally sharp and unpredictable movements in the market.
Simultaneous Opening of Positions Long and Short
Experienced players sometimes hedge their risks by opening two opposing (polar) positions. For example, long on shares of MTS (MTSS) and short on Megaphone (MFON). The reverse position does not open on the shares in the portfolio, since the purchased securities are already in long by default, but through taking additional volume of securities from a broker. If an equal number of shares is taken for a position and a counterposition, such a technique is called boxing in the trader jargon.
The opposite positions were based on the strategy of the first hedge funds . Managers open a long position on undervalued stocks and short on overvalued stocks. Typically, such a transaction is implemented through derivatives, for example, opening a short on an index futures or option . This allows you to take into account in advance the trend to decline, rather than sell stocks when the price has already fallen. When choosing the opening time and the size of a short position, the same tools of fundamental and technical analysis are used as in normal trading. In modern practice of hedge funds, robo-advisers (robots-advisers) based on complex mathematical algorithms are used.
A big plus deal long-short is that the cache in it is not needed. The downside is that it is extremely difficult for an ordinary trader to make money on opposite movements. It is not recommended to do to those who only master exchange trading. But large hedge funds have learned from this strategy not only to insure the risks of their clients, but also to extract billions in profits.
An important caveat: for simultaneous opening of multidirectional positions so that they do not mix, the use of separate contracts is required, and for one issuer – two accounts (subaccounts). If you open long and short on one account, it will be equivalent to closing a position.
Is It worth It to Short the Stock to a Novice Investor?
The main problem of an inexperienced investor is that he must have an accurate forecast of the movement of quotations, otherwise an operation with a short position will result in a loss. Such trading is not suitable for beginners who do not have the developed ability to analyze securities, forecasting experience and technical skills to conduct account transactions quickly. A short trade carries risks for both the investor and the broker. If the price unexpectedly goes up, the trader will not be able to return the borrowed and risen shares. Well, if the volume of the transaction is small, and the price rose not much. Then the losing trader will have to pay extra when returning the papers. But, even if the price drops to the necessary levels, but a short position will be open for too long, only the broker will win (at the expense of the commission).
In the event of an unfavorable development of events on long positions, the trader has the shares on his hands, for which he will be able to raise money after the return of a positive price trend. If you wait for this is not possible, then you should fix the loss, retaining part of its depot. In this case, the trader did not take a loan, does not pay interest on it, and owes nothing to the broker, except for the maintenance fee. In the case of a short position, the trader’s account is reduced by the amount of assets borrowed and the loan fee, up to zero.
There are situations that an investor must consider when opening a short. For example, a broker forcibly closes short positions on the eve of dividend cutoffs. Otherwise, he will not be able to receive income on shares credited. This is another reason why not securities, but futures more often shorts.
In the stock market, you can earn both growth and decline. Bidders have learned how to increase their financial results through the use of leverage. However, we must remember that margin trading increases not only profits, but also risks. In a long position, you can “sit out” in a drawdown and wait for new growth. Having taken a short position, you risk not only not guessing with the trend, but also giving the broker all the profit on account of the loan fee. Therefore, newcomers are strongly advised not to learn on short transactions.
Great article, Anton! Thank! It is important to understand the work of the mechanism of short positions, because losses can be significantly higher than the price of shares. We can only add that with longs the investor will always have shares with him – they will remain until the moment of their sale or liquidation of the issuer. And a lot of investors with the name and experience are advised to buy in a falling market and in no way short, especially investors in the literal sense of the word (and not speculators). They have a relation to falling as a “sale”, because a financially savvy person is always happy to buy stocks of a good and strong company at 20-30% cheaper.