Some beginner traders get confused between what is short trading, and short term trading.  That’s very understandable, as the phrases are almost identical! 

Short trading refers to the direction of a trade you undertake, whereas short term trading is a description of how long you intend to keep a position open.

In this article, we take a deep look at the concept of short trading.

We help beginners understand the concept of shorting a stock, and what the difference is between long and short trading. 

What is long and short in trading? 

The terms long and short in trading refer to the intended direction of your trade.

If you think the price is going to rise, you take a long trade.

This means you buy the stock or currency with the intention of selling it when the price has increased.

On the other hand, shorting a stock means you open a position with the hope it will decrease in value. 

Using CFDs (Contracts for Difference) you can make a profit in a downtrend when prices are falling.

In simple terms, this is done by first selling the stock, and then buying it back later at a lower price. 

This is what ‘shorting a stock’ means.

What is a long trade? 

Long trades are those where a trader buys an asset with the expectation that it will rise in price.  

They then sell it for a higher price, and the profit they makes will be the difference between the purchase price, and the sale price.   

This is the basic principle for all trading – making a profit by buying and then selling at a higher price.

What is shorting a stock?  

Short trades are the direct opposite of long trades. When you ‘go short’ you are hoping the price of the asset goes down.

Therefore, shorting a stock means opening a trade with the hope that the price will fall.  

How does shorting a stock work?

You short a stock by first selling the asset to your broker, and then buying it back at a lower price, pocketing the difference.

Only once derivative products and CFDs were invented did it become possible to make a profit from short trading a stock when the price is falling.

Shorting is only possible when using a broker. It is not possible to short a stock when you are buying that stock directly on the open market.

This is because shorting involves ‘borrowing’ the stock from a broker first, and selling it with the aim of buying it back later at a lower price.

A trader will open a short position by selling an asset they don’t currently own. Their intention is to buy it back later at a lower price, when the price of the asset has fallen.   

The profit achieved is the difference between the initial sell price, and the purchase price which then closes or ends the trade.   

Don’t worry if this seems a little confusing at the moment – all you need to remember for now is that short trading is the opposite of long trading. 

How to decide whether to go long or short 

In order to decide whether to go long or short, it’s necessary to understand price direction and volatility.

Volatility means the amount of movement in price in a period of time.   

A highly volatile asset will change in value quickly, as multiple transactions in the market drive the price either up or down. 

See the illustration below to see an example of low volatility, followed by high volatility price movement.

Low volatility is characterised by short candlesticks, where the open and closing price of an asset are close to each other. 

A highly volatile period of price action will have longer candlesticks visible.

There will be more distance between the open and closing price of the asset for the that period. 

These patterns of both low and high volatility are known as market patterns or market type.

You can find out more about different market types here.