Short Position Risk

Traders can take up two general kinds of positions in the market, whether involved with stocks, options, or exchange-traded funds (ETFs). The best known of these two is a long position. Under this approach, you buy shares of stock or an ETF (or an option contract). The sequence of events is the well-known buy-hold-sell.

Traders can also take up the opposite approach, the short position. Under this approach, you sell shares (or options) as a first step. This exposes you to substantially higher market risks.

For most traders, the long position is better known whether it involves all cash or margin (or other forms of leverage).
Traders who use short positions generally take much greater risks. So short position risk describes using the initial sale to create profits when the value of the stock falls, or involves the risk of loss if and when the value rises.

Short positions are used in a variety of different ways. Selling stock, a strategy called short selling, is a complex and potentially high-risk strategy. Under this approach, your brokerage firm borrows the shares of stock and lends them to you to sell. So you have to pay interest on the borrowed stock while also being exposed to market risk. You hope the price of stock will fall so you can close the position at a profit. If the price rises, the transaction ends up in a loss.

Most people new to trading will be likely to avoid short selling as an acceptable strategy. The risk level and cost of shorting stock are too high for most individuals; and with the use of options, it is possible to play a bear market without needing to go short.
By Michael C. Thomsett
Michael Thomsett is a British-born American author who has written over 75 books covering investing, business and real estate topics.

Copyrighted 2016. Content published with author's permission.

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