What is a Long or Short Position?

To be an effective trader, you have to know the vocabulary.

The basics are what type of position you hold in a stock. There are basically two: long and short positions.

Let’s take the long positions first.

What Does Long (or Long Position) Mean?

The buying of a security such as stock, commodity or currency, with the expectation that the asset will rise in value.

Keyword here is: rise in value. This is the opposite of “short” (or short position).
Here is an example:
An owner of shares in XYZ’s Corp. is said to be “long XYZ’s” or “has a long position in XYZ’s”. That person has bought the shares in the company in the belief that the stock price will go higher.

On the other side of the coin are the Short Positions.

What Does Short (or Short Position) Mean?

The sale of a borrowed security, commodity or currency with the expectation that the asset will fall in value.

Keywords here: fall in value. Opposite of “long (or long position)”.

Here is an example of a Short Position:
An investor will “buy a short position”. To do so, that investor must technically borrow the shares from a broker for a certain price. Once the investor “sells them” back to the broker, the gain/loss is determined.
If the price of the shares go down, the investor will make money on the trade.
If the price of the shares goes up, the investor will lose money on the trade.
Investors who believe that a stock price will go down, would be interested in taking a short position. Short positions can only be taken if the physical shares are held by a broker. That broker would then “borrow” those to you for the short position.
The reason why you have to have physical shares available for a short is to avoid the problem of everyone taking a short position when the stock begins to fall, causing a landslide in the price.
Taking a short position without the physical shares to borrow is called a “naked short”.

What Does Naked Shorting Mean?

It is now illegal to do this. It refers to the the practice of short selling shares that have do not exist. Traders must borrow a stock, or determine that it can be borrowed, before they sell it short.

Naked shorting does still exist due to various loopholes in the rules and lack of accounting in the paper and electronic systems.

Naked shorting is illegal because it forces a stock price down because there is not the supply/demand of the physical shares.

According to Investopedia website:
In 2007, the Securities and Exchange Commission (SEC) amended Regulation SHO to further limit possibilities for naked shorting by removing loopholes that existed for some broker/dealers. Regulation SHO requires lists to be published that track stocks with unusually high trends in “fail to deliver” shares. Some analysts point to the fact that naked shorting, albeit inadvertently, may help markets stay in balance by allowing the negative sentiment to be reflected in certain stocks’ prices.

What Does Short Squeeze Mean?

This occurs where this more demand for a stock, causing the stock price to go up. When this happens, traders with a short position will be forced to either sell their positions or cover by purchasing the stock. Eventually when enough “shorts” start to buy stock, the price of the stock will be pushed even higher.

Short squeezes occur more often in smaller cap stocks with small floats. A short squeeze is great for traders who are long, or looking for the share price to go up.

On the other side of the coin is what is called a Long Squeeze.

What Does Long Squeeze Mean?

The long squeeze is what happens when a stock’s price crashes. The saying, “everyone running for the door” applies here. As the stock price decreases, those with long positions will try to sell their positions to either take profits or avoid losses.

Long squeezes are more often found in small cap stocks with lower dollar volumes being traded, where a few traders can create huge swings in the share price in a short period of time.
According to the Investopedia website:
Short sellers can monopolize the trading in a stock for a brief period of time, creating a sudden drop in price. The main reason why long squeezes are so rare is that value buyers will step in once the price falls to a point deemed “too low”, and bid the shares back up. A rapidly falling stock, without a fundamental basis for the drop, will soon be seen as a “value” play, but a rapidly rising stock will be seen as increasingly risky with every upward tick.

Hope this all makes sense to you. If you are new to trading you might need to read this three or four times to get it.

Happy Trading!
PSR Team
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Tags: long position, long squeeze, naked short, short position, short squeeze