Investing in the stock market helps you put your money to work for you, based on the performance of the companies you invest in. However, you're not only limited to making money when the market goes up. Your stock portfolio can also hold long positions for the shares you expect to increase in value, and short positions for stocks that you think will decrease in value.
Exploring Long Positions
Long positions refer to what most people think of when they think of investing: buying actual shares of a company. For example, if you think Company J is going to take off, you could buy 100 shares of Company J so that when the price does go up, you can sell your shares at a profit. There's no time limit on how long you can hold a long position.
Understanding Short Positions
Short positions are what you use to make money when you expect the stock to go down. Instead of buying the shares, you borrow the shares from someone else and sell them, with the promise that you will replace the shares within a certain period of time. For example, if you think Company K's stock is going to drop, you could short sell 100 shares with the promise that you would replace them within three months.
Long and Short Options Contracts
It's important to know that long and short positions have different meanings when it comes to options contracts. Option contracts are an agreement that two parties enter into for the purpose of executing a transaction at a preset price or date.
Option contracts can either be put or call options, with the former giving the holder the option to buy a security at a certain price, and the latter giving the holder the option to sell a particular security for a certain price or before a certain date. Call options are generally a long position while put options usually demonstrate a short position on a particular stock.
Making a Profit With Positions
With a long position, you make money when the price of the stock goes up. For example, if you buy at $50 and it goes up to $60, you've made $10 per share. You also make money if the stock issues a dividend. On the other hand, short sales make money when the price of the stock goes down.
For example, if you short sell a stock at $50 per share and it goes down to $40, you've made $10 per share because you earned $50 per share from selling it and only had to pay $40 per share to repurchase it.
Exploring Potential Dangers
Of course, investments don't always work out as you expect. With a long position, the most you can lose is your investment. For example, if you pay $50 per share and the stock goes bankrupt, you lose your $50 per share investment, but nothing more. With a short position, your loses aren't limited because there's no limit on how high the price of the stock could go.
For example, if you short sell shares at $50 per share and the price goes up to $200 per share when you have to repurchase them, you're out $150 per share. Plus, if the stock you short sold pays a dividend before you buy the new shares, you also owe the dividend payment.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."