Investing in the stock market involves understanding various strategies, including buying (going long) and selling (going short) stocks and ETFs. Each approach has distinct characteristics, benefits, and risks. This guide provides a comprehensive overview of these strategies, including detailed examples and step-by-step instructions for executing trades.
Investors can gain exposure to companies, sectors, or industries by investing in individual stocks or through exchange-traded funds (ETFs), which offer diversified exposure. Before exploring the types of stocks available, it's essential to understand the directional stances investors can take: long or short.
Establishing a long position involves buying shares with the expectation that their value will increase over time. This bullish approach aims to sell the shares at a higher price than the purchase price, yielding a profit. Investors can establish long positions in various account types, including cash, margin, and IRA accounts.
Directional Bias: Bullish
Buying Power Effect:
Cash & IRA Accounts: Total cost of shares
Margin Account: Initial Margin: 50%* of stock value; Maintenance Margin: 25%* of stock value
Maximum Profit: Unlimited
Maximum Loss: Cost of the shares (only if the stock goes to $0)
Breakeven Price: Per share purchase price
Account Types Required: Cash, Margin**, IRA
Other Names: Equity, Stock, Shares
Margin requirement for a stock greater than $5 without elevated requirements and has margin privileges. Please visit the Efimarkets Help Center to learn more about long stock buying power requirements in a margin account.
Purchasing stock on margin requires at least $2,000 in marginable equity (cash and eligible marginable positions).
Action: Buy to open 100 shares of XYZ at $45
Cost: $4,500 debit
If the stock price rises to $50:
Sell to Close: 100 shares at $50
Profit: +$500
If the stock price falls to $0:
Loss: -$4,500
Establishing a short position involves selling shares you do not own, anticipating a decline in their value. This bearish strategy aims to repurchase the shares at a lower price, profiting from the difference. Short selling requires a margin account with specific trading privileges and carries additional risks and potential costs.
Directional Bias: Bearish
Buying Power Effect:
Cash & IRA Accounts: Not allowed
Margin Account: Initial Margin: 50%* of stock value; Maintenance Margin: 30%* of stock value
Maximum Profit: Share price x number of shares (only if the stock goes to $0)
Maximum Loss: Unlimited
Breakeven Price: Sale price
Account Types Required: Margin**
Other Names: Short Equity, Short Stock, Short Shares
The initial requirement for short stock is typically 50% or $10 a share, whichever is greater. Some stocks may have elevated margin requirements.
Selling stock requires a margin account with "The Works" and at least $2,000 in marginable equity (cash and eligible marginable positions).
Action: Sell to open 100 shares of XYZ at $45
Effect: $4,500 credit
If the stock price falls to $0:
Profit: $4,500 (credit received)
If the stock price rises:
Loss: Unlimited potential
Open an Investment Account: Choose a brokerage platform that suits your investment needs and open an account.
Fund Your Account: Deposit funds into your brokerage account to have capital available for purchasing stocks.
Research Stocks: Identify companies or ETFs that align with your investment strategy and conduct thorough research.
Place an Order:
Select the Stock or ETF: Enter the ticker symbol of the asset you wish to purchase.
Choose the Number of Shares: Decide how many shares you want to buy.NerdWallet
Set the Order Type:
Market Order: Executes the purchase immediately at the current market price.
Limit Order: Executes the purchase only if the asset reaches a specified price.
Review and Submit: Double-check the details of your order and submit it through your brokerage platform.
Log into Your Investment Account: Access the brokerage account where you hold the stocks or ETFs.
Select the Asset to Sell: Choose the specific stock or ETF you intend to sell from your portfolio.
Place an Order:
Choose the Number of Shares: Decide how many shares you want to sell.
Set the Order Type:
Market Order: Executes the sale immediately at the current market price.
Limit Order: Executes the sale only if the asset reaches a specified price.
Review and Submit: Confirm the details of your sell order and submit it through your brokerage platform.
The table below summarizes the key differences between taking long and short positions in stocks or ETFs:
| Feature | Long Stock | Short Stock |
|---|---|---|
| Market Bias | Bullish (expecting the stock price to rise) | Bearish (expecting the stock price to fall) |
| How It's Executed | Buy shares | Sell borrowed shares |
| Maximum Profit | Unlimited (stock price can rise indefinitely) | Limited (stock price can only fall to $0) |
| Maximum Loss | Limited to the cost of shares (if price drops to $0) | Unlimited (if stock price rises indefinitely) |
| Margin Account Required | No (can be executed in cash accounts) | Yes (must have a margin account) |
| Potential Risks | Market downturns, company-specific risks | Short squeezes, unlimited loss potential |
| Buying Power Effect | Full stock price required in cash/IRA; margin allows 50% buying power | Requires margin, initial and maintenance requirements apply |
| Example Trade | Buy 100 shares at $45 and sell at $50 = $500 profit | Sell 100 shares at $45 and buy back at $40 = $500 profit |
Understanding Risk - Long positions limit losses to the total investment, while short positions carry unlimited loss potential.
Margin Requirements - Short selling requires a margin account with sufficient buying power.
Market Conditions - Going long benefits from rising markets, while shorting benefits from declining markets.
Tax Considerations - Holding periods can impact capital gains taxes; short-term trades may be taxed at a higher rate.
Before placing trades, investors should ensure they understand the mechanics of long and short stock positions, their associated risks, and how they align with their overall investment strategy.
Buying and selling stocks is fundamental to investing. Whether taking a long position to benefit from stock appreciation or short selling to profit from a declining stock, traders must understand the risks, margin requirements, and execution methods. Using limit orders and stop losses can help manage risk, while diversification can reduce exposure to individual stock movements.
A well-informed approach, combined with an understanding of brokerage requirements, ensures that investors can navigate market fluctuations effectively while making strategic trade decisions.