Long and short positions
Both directions are available in every market covered here. The risk profiles are not symmetric.
9 min read · beginner · lesson 2 of 6
What this covers
- Define a long and a short position
- Explain how a short position is opened without owning the instrument
- Identify where the risk profiles of the two differ
- Account for the costs specific to holding a short
- Recognise the conditions that force a short to close
The two directions
- Long
- A position that gains when price rises. Opened by buying, closed by selling.
- Short
- A position that gains when price falls. Opened by selling, closed by buying.
- Covering
- Buying back to close a short. The word matters because it is a buy, and enough of them at once drives price up.
Selling what you do not own
In currency markets a short is structural rather than borrowed. Every currency pair is a ratio of two currencies. Selling EUR/USD is buying USD with EUR. There is nothing to borrow, because both sides of the transaction are currencies you can hold.
The same is true of futures. A contract is an agreement between two parties, and someone has to take each side, so opening a short is simply being the seller. No borrowing is involved and the two directions are mechanically identical.
In equities a short requires borrowing the shares from a holder, selling them, and buying them back later to return. The broker arranges this, which introduces several things a long position never encounters.
What an equity short carries that a long does not
- Borrow fee
- A charge for borrowing the shares, quoted as an annual rate and accruing daily. On an ordinary name it is negligible. On a scarce one it can exceed any plausible gain from the position.
- Hard to borrow
- When few holders are willing to lend, the fee rises and the position may not be openable at all. Scarcity and crowding arrive together.
- Recall
- The lender can demand the shares back. The position closes whether or not the timing suits, and at whatever the price is that day.
- Dividends
- A short holder pays any dividend to the lender. Holding a short through a payment date is a known, scheduled cost.
Where the two differ
| Long | Short |
|---|---|
| Maximum loss is bounded. Price cannot fall below zero. | Maximum loss is unbounded in principle. Price has no ceiling. |
| No borrowing cost in equities. | Borrow fees apply in equities and rise when shares are scarce. |
| Gains accelerate slowly. Doubling takes a 100 percent move. | Gains are capped at 100 percent. Price falling to zero is the limit. |
| A losing position shrinks as a share of the account. | A losing position grows as a share of the account. |
| Crowded longs unwind on selling pressure. | Crowded shorts unwind on forced buying, which accelerates the move against the position. |
A losing short gets larger by itself
This is the asymmetry that catches people, and it is arithmetic rather than psychology.
A long position that falls becomes a smaller part of the account. The exposure shrinks as the loss accrues, which is self-limiting.
A short position that rises becomes a larger part of the account. The exposure grows precisely as the position moves against you, so the risk increases at the moment it is least welcome. A short sized comfortably at entry is not comfortably sized after a 40 percent adverse move.
Forced covering
When a heavily shorted instrument rises, short holders buy to close. That buying pushes price higher, forcing more holders to close. The move feeds itself and can run far past any level justified by conditions.
Three things force the covering rather than inviting it: margin requirements rising as the position grows, a lender recalling shares, and a borrow fee that makes holding uneconomic. None of them are decisions the trader makes.
The same mechanic runs in reverse on crowded long positions, though margin structures make the short version faster.
Key takeaways
- A short gains when price falls and is opened by selling first.
- Currency and futures shorts are structural. Equity shorts require borrowing and carry fees, recall and dividend obligations.
- Loss on a long is bounded by zero. Loss on a short has no fixed limit.
- A losing long shrinks as a share of the account. A losing short grows.
- Covering is buying, so crowded shorts unwind by driving price further against themselves.
Common mistakes
- Holding a short in an equity without accounting for borrow cost over time.
- Sizing a short as though the downside is bounded the way a long is.
- Assuming a short can be held as long as intended, when a recall can end it.
- Shorting a heavily crowded name without accounting for how the exit behaves.
Knowledge check
OptionalRelated
- Orders and executionMarket Foundations
- Position sizing and risk per tradeMarket Foundations