Long Position vs. Short Positions
A long or short position are the two major types of positions that one can have in any financial market when you are trading an asset or a financial instrument. Although many would think long and short are the same as buy and sell, there is more to it.
The fact is, having a long or short position has a different meaning in each financial market. It does not mean the same thing in the stocks trading as it does trading options. The same is true for the forex market.
In this article, we are going to discuss these two important notions with a focus on the Foreign exchange market, or forex, with an additionally general approach that can be extended to all markets. So, what is the difference between a long and a short position?
What Is a Long Position?
As we mentioned at the beginning of the article, both the definition of a long position and also a short position can vary a lot in various financial markets. We are mainly going to focus on the forex market and its relevant definitions, but we will also provide you with a general view of these terms.
With that in mind, we can define a long position as the position a trader would assume if they believe that the market is going to take a bullish turn. In other words, the trader is of the opinion that the value of the asset or financial instrument in question is going to increase.
With that assumption the trader will take a long position in the market.
As far as the forex market is concerned, taking a long position in the forex market would equate to going long on the base currency in the currency pair. The base currency is of course the first one in the pair.
So when you take a long position with a currency pair in the forex market, it would mean that you are expecting an increase in the value of the base currency against the value of the second currency, or the quote currency.
In this way, you are going to pay the quote currency to receive the base currency.
What Is a Short Position?
A short position is naturally the exact opposite to a long position. Keep in mind that there are variations with regard to the definition of a short position in different markets, however, the general understanding of a short position would be a position in which the trader believes the market as a whole or a certain instrument is going to take a bearish turn and move into a downtrend, though maybe for a short period.
So we can conclude that the short position is one in which the trader anticipates prices will decrease in the market. As far as the forex market is concerned, the short position that you would take also has to do with the base currency in the currency pair.
This means when you short a currency pair, you are expecting that the price or value of the base currency is going to decrease against the value of the second currency in the pair.
So the exact opposite of the long position is going to happen. You are in fact selling the base currency and receiving the quote currency.
Again, this is because you think the value of the fist currency is about to decrease against the second one.
How Do You Profit from a Long Position?
In the forex market, and by extension in all markets, the way you benefit from taking a long or short position are rather similar.
In the foreign exchange market, your profit from a short position will come from the spread between the price of the pairs before and after your position.
So imagine the price of a currency pair X/Y equals 10. This means you need 10 Y currencies to purchase one unit of the X currency. When you go long on this pair, you expect that the value of X is going to increase.
When it eventually happens, the price of the pair could increase to 12. It means that for each unit of X at the beginning of the position you had 10 Y currencies. But now, because of your position, for every unit of X you have 12 Y currencies.
The spread is the profit that you have gained from your long position. Of course, standing alone, it might not seem like much. But remember that the size of trades in the forex market are for instance 10,000 or even 100,000 units of the base currency. So multiply that spread from your long position with the size of the trade, and you can see an incredibly high profit margin.
How Do You Profit from a Short Position?
Again, the way you can obtain profits from a short position is the opposite of the way you make profits from a long position.
So suppose the price of a currency pair of X/Y is quoted to be 10. According to your analysis, the value of this pair is going to decrease, which means the value of the base currency is going to drop against the value of the second currency.
So based on this analysis, you decide to short this pair. Following your short position, the quoted price of the currency falls to 8. This means that instead of 10 Y currencies, now you only need 8 Y currencies to purchase one unit of the X currency.
So because you shorted the pair, now you can purchase one base currency with 8 units of the second currency, but now you have 2 extra units of Y currency. So this means now you can purchase more of the base currency.
This is basically how you can profit from a short position in the forex market.
Benefits of Long and Short Positions
The benefits of long and short positions are rather obvious in that they can help you make profits through buying low and selling high, or the opposite which is selling high and buying low.
In either case, you are actually making profit from the spread of your buy and sell orders in the market as a result of your initial position.
But an added feature of these positions can be their risk management property. Remember, first and foremost, they are going to help you not to incur further losses in the market.
In any financial market, you can take two main positions. One of them is called a long position and the other is a short position. In their essence, these are the two main approaches you can have toward the market. Basically, a long position is one that involves the trader anticipating an increase in prices so they basically decide to buy. On the other hand, in a short position the trader expects that the price of the asset will fall. So they decide to sell their asset according to this anticipation.