Short Position (Trading) - Explained
What is a Short Position?
Written by Jason Gordon
Updated at April 17th, 2022
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What is a Short Position?
A short position is a directional position used by investors when trading securities in the market. This position entails a trader selling a security with the aim or repurchasing the same security when there is a decline in security price so that he can make a profit. A short position is often used by investors when they perceive there would be a fall in the price of security. There are two types of short position, they are;
- A Naked Short: this position is when a trader sells a security that he does not own.
- A Covered Short: this involves a trader borrowing securities from a stock loan department to trade in the market.
In the United States, a naked short position is illegal and investors are warned against such.
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How Do Short Positions Work?
Short positions are often taken in futures contract or in the foreign exchange markets. This position allows a trader to sell a security which he then buys back at a lower price. Short positions can be created at any time and used as a strategy for earning profits. However, short positions come with the risk of short-squeeze, this is when a shorted security begins to rise in price rather than fall in price as projected by the trader. This is dangerous for investors that take short positions in the market and could cause potential losses. The major instance of short-squeeze occurred in 2008 where investors who took short positions suffered losses due to a continuous increase in the price of the securities.
A Real World Example
Short position is common in the foreign exchange market and futures contract. One of the real life examples of short position was when a n investor leverage on the quarterly report of amazon to take a short position in the market. After taking the short position with 1,000 borrowed shares from the stock loan department, the price of the shares declined as projected and the trader made a profit on the shares. For instance, if each share was sold for $1,000 and the price falls to $700, after repurchasing the shares, the trader has made a $300 profit on each of the shares.
