A basic concept that must be understood before learning about specific order types is the direction in which a trade can be established. Trades can be entered in two different directions, depending on the anticipation of a rising or falling market. Long trades are the classic method of buying with the intention of profiting from a rising market. Long trades can be conducted through all brokers and do not necessarily require the trader to have a margin account (assuming the account has funds to cover the transaction). The losses from a long trade are considered limited (even though these losses could be extensive). This is because if a long trade is entered at any level, price can only go as low as $0 if the trade moves in the wrong direction.
Short trades, on the other hand, are entered with the intention of profiting from a falling market. This is accomplished by borrowing a stock, futures contract or other instrument from a broker and then selling them. Once price reaches the target level, traders buy back the shares (or contracts), or buy to cover, and replace what was originally borrowed from the broker. If price drops, the trade may be profitable (depending on other factors such as slippage and commission); if price rises, the trade will be a loss. Short trading requires a margin account with a broker, since the trader must borrow shares/contracts from the broker in order to complete the transaction. Not all trading instruments can be sold short, and not all brokers offer the same instruments for short sale.
Long Trade = profit from a rising market
Short Trade = profit from a falling market
Trading short positions is an important part of active trading because it allows traders to take advantage of both rising and falling markets. Unlike long trades, where losses are limited, short trades have the potential for unlimited losses. This is because a short trade loses value as the market rises, and since price could theoretically continue rising indefinitely, losses can be unlimited - and catastrophic. Trading with a protective stop-loss allows traders to manage this risk.
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