Long Position Meaning
The meaning of the term ‘Long position’ denotes buying of a stock, currency or commodity in the hope that the future price will get higher from the present price. The security can be bought in the cash market or in the derivative market. The course of action suggests that the investor or the trader is expecting an upward movement of the stock from is prevailing levels.
Components of Long-Position
In order to have a long position investor need to have the following components:
- A trading account, from where investors can do buy and sell of stocks, currency, and commodities.
- There should be a selection of particular security or an asset class in order to take a “Buy” call on a stock or any asset class.
- The foremost factor which is required for a long position is the requirement of capital or funds. The investor has to invest capital in order to get long-term returns on investment.
Examples of Long Position
Below are some examples.
Example #1
An investor has researched a particular company and wants to own a stake in the company. The stock price is quoting at $195 per share and is available at a price to earnings (P/E) multiple of 18.5x of its trailing twelve months (TTM) earnings per share (EPS).
While the average industry median of the stock is quoting at 14.8 times. Thus, the investor likely to choose a long stance when the valuation is available at per the average industry median. Thus, the investor would choose to ‘Buy’ and hold the stock for a long-term perspective.
Thus, the act of buying the stock is known as ‘Long position’. Suppose the price of the stock corrects by ~21% and on the valuation front, the stock is trading at 14.6x as compare to the current average industry median of 15.2x. Thus, this is the right term when the investor would take a ‘long position’ on the stock.
Example #2
After taking a long position at a price level of $50 per share, the stock price fell to $46.2 per share. The reason for the fall is the lower investor sentiment, while the fundamental of the stock remained intact. Thus, the investor can increase its stake as the price has fallen. Again, within a few more weeks, the stock corrected another ~10% and quoting at $41.8 per stock.
Thus, before taking any further position, the investor should take a look at the current TTM and the valuation. If the current TTM increases, then the valuation-wise the stock would be trading at an attractive level and the investors could opt to further increase his stake.
Advantages of Long Position
- One of the prime reasons behind the ‘long-position’ is the capital appreciation in the investor’s portfolio. The prime reason for buying a stock is that the investor is bullish on the stock and is expecting an uptrend in the price of the stock in the future.
- The investors enjoy all the positions of owning the stock like – participation in the voting of the company, recipient of dividends, etc.
- Most of the Investors do a detailed study of companies and buys a stock in the hope that the stock would appreciate it. Thus, to get multiple folds of returns, an investor has to buy a stock for a long term basis through the ‘long’ position.
- In a bull market scenario, both the traders and investors get benefited from the long position as the price of the stock, commodities, etc tend to rise.
- There are a few categories of stocks like slow growers, growth stocks, stalwart categories, cyclical, etc. The growth and cyclical stocks tend to slump during the bear market while slow growers and stalwart categories tend to increase irrespective of the market conditions. Thus, the long position gives higher returns for value investors and for long term investors.
Disadvantages of Long Position
- One of the major disadvantages of a long position is the erosion of stock price during downtrend or in the case of the bear market scenario.
- The investors have to cut their position and book losses when the stock price or the commodity price slumps.
- There is no option for the traders to make any short position in the derivative segments and hence they cannot make profits from a falling market.
- There are traders in the stock market who tend to sell during tepid economic conditions resulting in bear conditions. But to the nature of the long positions, the trader has only one option.
Important Points
- The long position is applied only during the buying of security and hence only applicable for the long-term investors or traders who have a short-term bullish view.
- During market volatility, the long position is not enough to beat the market. Again, during bear market conditions, a long position is not enough to make profits from the falling stock prices.
- The long position is popularly used by the investors during the bull market or in case of any growth stocks which was bought in the hope of capital appreciation.
- In most cases, investors do research a particular scrip on the basis of the fundamental growth story of the company and stay long for a long-term perspective or until the financials of the company are intact.
- The long position is broadly used across the derivative segment in case of currency, stock, and commodities.
Conclusion
Stock market lure investors, where they can invest and earn a handsome return on their current investment positions. The art of investing is dependent on buying the stock at a lower valuation and selling it at a price that will give many folds return to the investor. The return of investment would be higher if the timing of the investment remains favorable for the investor.
The thumb rule is to buy a fundamentally good stock at a price level when no one is interested to buy and to sell the stock where everyone is positive and willing to invest in the company. Thus the investors have to take a long position in order to invest in the long term horizon.
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