SIE: 8.4.4.1. Buy And Sell Orders

8.4.4.1.  Buy and Sell Orders

An order is a request to buy or sell a security. An investor who buys a security becomes the owner of the security. This is also called having a long position because the owner of the security is not planning to sell it right away but instead is going to hold it for some period of time. An investor goes long when he expects the price of the security to rise in the market. Recall that we call this a bullish strategy because the position will profit if the security rises in price. The maximum loss on a long position is the money that was invested.

When an investor sells a security, he can sell long, which means to sell securities that he already owns. Or he can sell short, which means to sell securities that have been or will be borrowed. (This is also called having a short position in a security.) An investor sells short when he expects the price of the security to drop in the future. His goal is to sell at a high price and buy the shares back in the future at a lower price, profiting from the difference. Because a short seller will have to buy back the shares sometime in the future, and during that time the price of the shares could, hypothetically, rise infinitely, the short seller’s risk is infinite. A short seller’s gains are capped by the price of the security going to zero. In other words, a short seller earns his maximum profits when the price of the security goes to zero. Because a short seller will profit when the price of the security goes down, short selling is considered a bearish strategy.

In contrast, the maximum loss of a long position is simply the amount that the investor initially invested. Because the stock price could rise infinitely, the maximum gain on a long position is unlimit