Long Position
Last Updated :
21 Aug, 2024
Blog Author :
Wallstreetmojo Team
Edited by :
Aaron Crowe
Reviewed by :
Dheeraj Vaidya
Table Of Contents
What Is A Long Position
A long position denotes buying a stock, currency, or commodity, hoping that the future price will get higher than the current price. The course of action suggests that the investor or the trader expects an upward stock movement from its general levels. The security can be bought in the cash market or the derivative market.
Stock markets 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 on investment will be higher if the timing of the investment remains favorable for the investor.
- A long position involves buying a stock, currency, or commodity to sell it at a higher price in the future. This indicates the investor or trader's expectation of a price increase.
- The components of a long position include the trading account used for the transaction, the specific security or asset class being bought, and the capital or funds required to execute the purchase.
- Long positions are commonly seen in currency, stock, and commodity derivatives markets, where investors and traders seek to profit from anticipated price rises.
Long Position Explained
In the investment world, the term long position in stock market refers to the owning or buying an asset, or stock or any kind of financial instrument and holding it, with the expectation that the price will rise in future. Thus, when the price rises, it can be sold to earn profit.
The long position is applied only when buying security and hence only applicable to long-term investors or traders who have a short-term bullish view. During market volatility, it is not enough to beat the market. Again, it is not enough to make profits from falling stock prices during bear market conditions.
Investors popularly use the long position during the bull market or in case of any growth stocks bought in the hope of capital appreciation.
In most cases, investors do research a particular script based on the fundamental growth story of the company and stay long for a long-term perspective or until the company's financials are intact. This position is broadly used across the derivative segment in currency, stock, and commodities.
The thumb rule is to buy a fundamentally good stock at a price level when no one is interested in buying and selling the stock where everyone is positive and willing to invest in the company. Thus, investors have to do long position trading to invest in the long-term horizon.
Components
Let us try to understand the various components of long position in stock market in detail.
- A trading account from which investors can buy and sell stocks, currency, and commodities.
- There should be particular security or asset class selection to take a "Buy" call on a stock or asset class.
- The foremost factor which is required is the requirement of capital or funds. The investor has to invest capital to get a long-term ROI.
Examples
Below are some examples which will help us to understand the concept.
Example #1
An investor has researched a particular company and wants to own a stake in the company. The stock price is quoted at $195 per share and is available at a price to earnings (P/E) multiple of 18.5x it is trailing twelve months (TTM) earnings per share (EPS).
While the average industry median of the stock is quoted at 14.8 times, thus, the investor is likely to choose a long stance when the valuation is available per the average industry median. Therefore, the investor would choose to 'Buy' and hold the stock from a long-term perspective.
Thus, buying the stock is known as a 'Long position.' Suppose the stock price corrects by ~21%, and on the valuation front, the stock is trading at 14.6x compared to the current average industry median of 15.2x.
Example #2
After taking a net long position at a price level of $50 per share, the stock price fell to $46.2 per share. The fall is the lower investor sentiment, while the fundamentals of the stock remained intact. Thus, the investor can increase its stake as the price falls. Again, within a few more weeks, the stock corrected another ~10% and quoted at $41.8 per stock.
Thus, before taking any other position, the investor should look at the current TTM and the valuation. If the current TTM increases, then valuation-wise, the stock would be trading at an attractive level, and the investors could opt to increase their stake further.
Advantages
Investors may go for long position trading and purchase the asset with the intention of making profit during price appreciation. The following are the benefits of the procedure.
- 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 stock price 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 Investors do a detailed study of companies and buy a stock hoping that the stock will appreciate it. Thus, to get multiple folds of returns, an investor has to buy a stock long-term.
- In a bull market scenario, both the traders and investors benefit from the net long position as the stock price, commodities, etc., tend to rise.
- 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, it gives higher returns for value investors and long-term investors.
Disadvantages
Taking a long position also has some significant disadvantages as given below:
- One of the significant disadvantages is the erosion of stock price during a downtrend or in the case of a bear market scenario.
- The investors have to cut their position and book losses when the stock price or 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.
It is necessary to understand the investment strategy's benefits and limitations before making any decision. It is advisable to take the help of finance professionals or investment advisors who will guide the investor.
Long Position Vs Short Position
Both the above financial terms represent two different investing strategies that investors use in the financial market. But there are some key differences between them as follows:
- The investor anticipates a rise in price in case of the former, whereas in case of the latter, the investor anticipates a fall in price.
- In case of the former, the investor buys the financial security and holds it, whereas in case of the latter the investor does not actually buy it but borrow and sell it so that when price falls, they can buy it to make profit.
- The holding period of the security in case of taking a long position is usually extended from a few months to years, whereas short, the holding period may vary.
- In case of the former, the investor gains when the price rises whereas for the latter the investor gains when the price falls.
- The risk for the former lies in the fact that the price will fall in future and risk of the latter lies in the fact that the price will rise in future.
Thus, the above are some important differences between the long and short position.
Frequently Asked Questions (FAQs)
The primary risk of a long position is that the asset's price may decrease, resulting in potential financial losses for the investor. Market volatility, unexpected events, changes in economic conditions, or poor company performance are factors that can lead to a decline in the asset's value and negatively impact the long position.
Investors take a long position in the stock market because they anticipate that the asset's price will increase over time. Reasons for a long position include positive expectations about the company's financial performance, industry growth prospects, favorable economic conditions, or a belief that the asset is undervalued.
Determining the right time to enter or exit a long position requires careful analysis and consideration of various factors. Investors should thoroughly research the asset, its fundamentals, and market conditions. Technical analysis, price trends, and indicators can help identify entry and exit points. Setting clear investment goals, defining risk tolerance, and having a well-defined investment strategy is crucial in making informed decisions about entering or exiting a long position.
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