Buying Long vs. Selling Short – Don’t Be Confused by the Long and Short of Investing/Trading (Long-Term Investing differs from Short-Term Trading, which differs from buying long and selling short)
Confused by the Long and Short of Investing?
Long-Term Investing vs. Short-Term Trading – Is that different than Buying Long and Selling Short?
The stock market is confusing and overwhelming. It doesn’t matter if you are a beginner or if you’ve been trading or investing for a long time. There’s just so much going on in the market and it all seems to change every second.
I had the honor of appearing on both CNBC, interviewed by Melissa Lee, http://www.youtube.com/watch?v=e4NX7DaArPU and on Yahoo Finance, interviewed by Jeff Macke, last month, http://finance.yahoo.com/blogs/breakout/16-old-actress-turns-stock-day-trader-143823005.html. After those interviews aired February 2013, I received so many great questions from Facebook, twitter, and email. Some were from beginning investors, while others were from intermediate and advanced traders. Over and over, there seemed to some confusion between long- and short-term trading as far as how long a person holds their stock purchases, and the how that relates to Buying Long and Selling Short.
The purpose of this blog is to define the difference between Long-Term Investing and Short-Term Trading, and explain how that is completely different from buying Long and selling Short.
For those that are perfectly clear on that distinction, read on….. and please comment to share your wisdom. These topics may be old hat for advanced traders, but not second nature for others.
The Distinctions of LONG and SHORT in investing/trading:
Distinction #1: Long-Term Investing vs. Short-Term Trading – refers to the length of time you hold the stock before selling or before buying to cover.
Distinction #2: Investor vs. Trader
The amount of time you hold onto a stock denotes whether you are usually an investor or a trader.
Investor – usually holds stock for longer periods of time, like months or years
Trader – usually holds stock for shorter periods of time, like minutes, hours, or days
Distinction #3: Buying Long vs. Selling Short
Buying Long – buying a stock, then making money when you sell that stock
You make money ONLY IF its price goes up
Selling Short – selling a stock you borrow, then making money when you buy that stock at a lower price and give back the stock you borrow; if the stock price rises and you have to buy that stock at a higher price before you give it back, you will lose money
You make money ONLY IF its price goes down
Distinction #1 and #2 are related. Distinction #3 is not necessarily time-based, but it is based on whether you think the stock price will go up or down. There is a time component of Buying Long vs. Selling Short, and it is this: You can Buy Long for a short-term trade AS WELL AS a long-term investment. However, you usually Sell Short for a short-term trade. Short sales are not usually done over long periods of time. Why? From tradingdirect dot com:
“For short sales on stocks … there may be interest-like fees (known in the industry as “negative rebates”) associated with carrying the short position. This interest will accrue from settlement date of the short sale until settlement date of the buy-to-cover, and will be charged daily.”
A few thoughts about short selling:
1) Most people Buy Long and don’t Sell Short. Why?
a. It is VERY risky to sell short. If the stock price rises to infinity, your loss can be infinite. That’s a lot of money to lose ☺
b. Many people do not know they can sell short.
c. Many people do not know how to execute a short sale.
d. You must have a margin account in order to sell short.
2) Many people think they can only trade when the Dow is going to go up, meaning when the market and the stock prices are going to increase. They think that they cannot make money buying a stock if they think the market is going to go down. Why do they think this? Because many people are not aware that they can sell short and they think their only option is to buy a stock projecting its price will go up. This can prevent people from investing or trading if they are bearish and do not believe a stock or stocks will rise. This is especially true when the economy is showing mixed signs, such as an increasing S&P500 with higher unemployment. People may feel confused and not want to partake in what I call “BiPolar Trading.” See Stock Terms at www.foxonstocks.com/stock-market-terms/
3) You can only sell short when there is stock available to borrow.
4) If the stock price goes down as you thought it would, you then “Buy to Cover,” which means you buy the stock from someone else on the open market at the lower price. You take those shares you just bought and give them back to the person you borrowed them from.
I could write on and on about Short Selling. It’s so clever and so chic and very difficult and quite complex and risky, all at once. That said, I do not recommend short selling to anyone unless you know EXACTLY what you are doing and you know that you have unlimited loss potential when you place a short sell trade.
Now that you have your LONG and SHORT distinctions clear, you can go out into the stock market and do your Long this or Short that. Knowledge is power. YOU’VE GOT THE POWER!
Many Happy Returns,