Basics Of Securities Trading: Long Position & Short Selling

Mukunda Tripathee

The act transferring the ownership of financial assets such as shares, bonds, treasury securities, etc from one person to another person through organized or unorganized security markets is called security transaction.

Investment Plan

First, the investor should set the goal of the investment plan-long term or short term. If the investor’s plan is long term, either that is a capital incentive or long term fixed income plan, the investor should transact in common stocks, preferred stocks, bonds, debentures, and so on. Likewise, if the investor’s plan is short-term, that is cash/dividend incentive plan within a short period, he/she should transact in commercial paper, certificates of deposits, bankers’ acceptance, treasury bills, and so on.

Security market is the combination of the Bull and Bear market. So, it is difficult to predict when the price of securities will rise and fall. Share markets are volatile markets. So, keen consideration is required before investing in securities.

So, before investing hard-earned money into different securities by the prospective investors, they should have knowledge about types of securities transactions, how the transaction can be performed?  Investors should be rational and calculative to gain from security transactions. There are two basic three types of securities transactions: Long Position and Short selling.

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Long Position

In the long position, investors invest in securities today with the expectation that securities prices will rise gradually in the future. Investors prefer long positions to buy the securities at present comparatively at a lower price and hold them until the price goes up and sell at a higher price. Therefore Long position is a “buy low and sell high” approach. Long purchase is the most common type of securities transaction because investors invest in securities with the expectation of increment of securities price in the future. Through the long position, investors can acquire two types of benefits from their investment. First, investors either get dividends or interest from securities. Second, they get to benefit from capital gain by selling securities with the risen price. There is a risk to investors if the price of securities will fall in the future.

Rate of return from long purchase:   [(Selling price-purchase price)+ cash income]/Purchase price

Short Selling

In short selling, investors sell the securities today by borrowing from the brokerage firm. Here, the investor sells securities that he/she doesn’t actually own yet. The basic assumption in short sell is that the price of securities will fall in the future. So investor borrows securities from brokerage firm today and sells at a higher price. Then, the investors buy securities from a brokerage firm in the future date whenever the price of securities falls and refund to the brokerage firm thereby recovering from a short position. Therefore short selling is a “sell high and buy low” approach. The rise in the price of securities in the future is the risk to the short seller.

Most of the investors assume that to get benefit from securities transactions, the price of securities must have to raise. That may be wrong. Because intelligent investors can capture the benefits from securities transactions through short selling as well if the market trend is a downward movement in securities prices too. So, the short-seller gains the benefit of the bear market. However, in the case of short selling, if a stock pays a dividend, the short-seller shall have to refund to the brokerage firm because of not being the real owner of securities. Similarly to commence a short selling transaction, the short seller requires depositing some of the initial equity into the brokerage firm.

Rate of return from short sell:   [(Short sell price-purchase price)-cash income]/Short sell price

(Mr. Mukunda Tripathee is currently working in the banking sector)

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