6.5.1 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 in a security. When an investor sells a security, the sale occurs in one of two ways: he can sell long or sell short. If he sells long, he is selling securities that he already owns. If he sells short, he sells securities that have been or will be borrowed. An investor sells short when he expects the price 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.
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 unlimited.
Example: Sam shorts 200 shares of XYZ @ 35. His maximum loss is infinite. His maximum gain occurs if the price of XYZ goes to zero, where he will earn $7,000.
Example: Ray goes long 200 shares of XYZ @ 35. His maximum loss is the amount that he has invested, $7,000. His maximum gain is unlimited.
An investor who buys a security and hopes that the price of the security will rise is said to be bullish. An investor who sells short expects