Selling Short or Going Long
Going long is a term used when someone buys a stock. If you go long you are buying a stock and holding it for a period of time. The time period can be any length but when you buy it is often called going long. The transaction simply involves buying a stock through your brokerage account and moving it into your own account.
Going short is term used when someone sells a stock with the intention of buying it back later at a lower price. The stock is typically is “borrowed” from the broker who expects it to be returned at some point.
You are borrowing a stock that you intend to sell on the open market to another investor. The price could be $10 per share from your broker and you sell immediately 100 shares to someone else for $1000. The stock then drops $2 per share and you buy it back, or cover your short, (see more on short covering here) at $8 per share.
It cost you $800 to buy back the stock needed to return to your broker. The broker only wants the shares back and is not concerned about the price. Therefore you can meet your obligation for only $800 dollars. The $200 is the profit that you have made on the trade.
If you are correct in your assumptions that the stock will drop you will profit. However, if you are wrong, your loss on a short sale could be infinite if you continue to hold the stock.
It is important to set a loss limit on your shorts in case the stock begins a long run up.
(See more on stop limits, and t-stops here.) If you have to pay $1200 to buy back stock to replace what you borrowed at $1000, you will lose $200. There virtually is no limit to your losses on a short sale because theoretically the stock could go up forever. Compare this to a long stock holding and it begins to drop the loss will stop at its maximum when the stock hits zero.
This book will show you hot to read charts and to follow trends. It is a good book for anyone trading in stocks. How to Make Money in Stocks: A Winning System in Good Times and Bad, Fourth Edition