Introduction

Disclaimer:

This article intends to give you very basic information on the differences between long and short positions and the fundamental concept behind them. It shall not be seen as trading advice of any kind. All examples and prices are fictional and should be used for information purposes only.

Long and Short Positions are two different ways how you can trade on the stock market.

Both strategies come with their pros and cons.

We encourage you to do further research for a more in-depth understanding or talk to the Customer Service Team directly if you are unsure.

What are long positions?

Long positions can be viewed as the traditional way of investing in financial markets: Buy a stock, hold it until its price has been increased and sell with a profit at some point in the future.

The market value of a financial instrument might fluctuate and can go up or down due to market conditions and other factors.

The difference between the money you receive after the sale, compared to the amount of the initial investment, is known as either a profit or a loss.

Example: (trading fees are excluded for scenario simplicity)

You decide to buy stock ABC with the current market price of $10.

There are no time limits on how long you can keep the stock.

If the market price of stock ABC goes up to $15 and you sell it, you have gained a profit of $5

If the market price of the stock goes down to $5 and you sell it, you have received a loss of $5.

Opportunities and Risks

This example indicates that your profit or loss is determined by the market price of the stock at the time when you sell it.

In this scenario, your potential profit is limitless, as the value of a company could rise over X amount of years. Your profit would rise equally.

Your potential loss is limited to the investment you have made.

In the worst-case scenario, where a significant drop in the market price of the ABC stock occurs or the stock is delisted, you will incur losses related to this stock. Unless you place a stop loss on this position, the loss of your investment would amount to the capital invested in ABC stock initially.

In our example, where no stop loss has been set up, your maximum loss would be $10, if the market price drops down all the way to $0 or these shares are delisted.

What are short positions?

As the name states, short positions are the exact opposite of long positions.

Instead of your profits aligning with the growing market price of a stock, your profits will increase only in case when the market price of the stock is dropping.

Please keep in mind that for short positions, the ownership of the stock does not incur as it happens when you open a long position.

Example: (trading fees are excluded for scenario simplicity)

You want to open a short position in stock ABC, which is currently trading at $10.

Now, since you do not own stock ABC, the broker (in this case Freedom Finance) will lend you the stock for the short position. You will have the obligation to return the stock to us later on. This means you will only be able to liquidate this short position via Freedom and will not be able to transfer it to another broker.

(Your account needs to have marginal trading enabled if you want to borrow assets from us. More information about it here: What is marginal trading)

If your account as marginal trading enabled, you can open a short position in stock ABC (selling said stock) at the current market price of $10. You will notice that you have received $10 after the execution of the order.

At some point, you may wish to liquidate this short position at market price or place a limit order. Once the short position is liquidated, the stock will be returned to Freedom.

If the market price of the short position in stock ABC drops to $5 at the time when you liquidate this position, your profit will amount to $5.

If the market price of stock ABC goes up to $15 and you decide to liquidate your position, your losses will amount to $5.

Opportunities and Risks

Your maximum potential profit can only be the value of the stock at the moment you opened the short position.

To achieve the maximum profit from a short position, a significant drop of the stock’s market price needs to happen.

In the best case scenario, the stock value drops all the way down to $0.01 (not realistic, for scenario simplicity only).

To liquidate the short position, you will need to buy back the shares you sold for it. The difference between the amount you have to pay now to buy it back and the cash you received when opening the short position is your profit.

Your potential maximum loss in theory is limitless if no safety measures like e.g. stop loss had been set up or you do not close the short position manually.

Companies do not have a limit, how valuable they could get.

In a hypothetical scenario where you opened a short position in the stock trading at $10 and the price reaches £100 when you decide to close the position, your losses will amount to $90.

Additional Considerations

Not all stocks are available for opening a short position
In the case of market volatility or crash, local regulators can impose a temporary prohibition on short trading or other restrictive measures.
Please note, as you do not own the underlying stock on the short positions, you are not entitled to receive dividends on the stock. Moreover, if the distribution of dividends on the underlying stock takes place when you have an existing short position in such stock, you will be obliged to pay the dividends equal to the amount of the dividends paid to investors. More information about this here: Common types of corporate actions
Detailed information about the fee schedule can be found here

Conclusion

The risks and potential losses associated with short positions are much greater than those associated with long positions. This is why short positions are typically recommended to clients who are experienced traders, fully aware of the risks, potential earnings and losses, as well as market trends. Additionally, there might be position limits related to the maximum amount you can invest in short positions depending on your level of experience and financial circumstances.

Freedom can only lend you financial instruments for opening short positions equal to the total value of your portfolio. This is designed to limit the overall losses.

If the total value of your portfolio amounts to $1000 (this includes your open positions and cash on account), your short positions will be closed automatically before your losses exceed $1000.

Please read this article for more information about how we calculate the value of your portfolio and the risk assessment: What is marginal trading.

Our platform also offers additional options to automate trading and place limits on maximum profits and losses.

Please read the article about How to set Stop Loss and Take Profit.

In summary, long positions are better suited for investors who believe that the market price of the stock will increase over time; whereas short positions are typically used for short-term profits, in hopes of a decrease in the value of the underlying stock.

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