Going Long: 'Buy Low and Sell High'

by Alex Cruickshank

Most investors are aware that to be successful at the stock market you should buy low and sell high. What less people know is that you don't essentially have to do it in that order. Buying low and selling high means that you are 'long' on a particular asset. For instance, if you buy shares in Skullcrusher's Friendly Bailiff Debt Grabbers Plc at a price of 10p, in the belief that they'll reach 50p on the back of increasing debt defaults, you are long on that trade.

Going Short: 'Sell High and Buy Low'

But you could also sell high and buy low. If you are of the opinion that Skullcrusher doesn't have much of a future because there's very little money left to collect, you could short the stock. This would involve borrowing the shares, selling them at 10p and hoping to buy them back at 2p, for instance. In this case you would be short Skullcrusher Plc.

Not all brokerage houses allow this, but going short means that you borrow something you don't own, sell it and then buy it back later at a (hopefully) lower price, returning it to the person you borrowed it from cashing the difference in the process. It simply means that the lower the price goes, the more money you can make.

Going Long and Going Short: To Buy and To Sell

You usually do not have to worry about the intricacies of how a long or short trade actually works; who lends you the shares, what interest or fees you pay on them...etc. Many trading companies, in particular those with an established web presence, make it very simple: click on the asset you want to trade and you'll be presented with two boxes: one to buy (long), one to sell (short).

The prices in the two boxes will be different: the buy price will be lower than the sell price. The difference between the two is referenced as the bid/offer spread or bid/ask spread, and is how the trading companies make their money (the exception here is companies who charge you a fixed fee per trade). It means that, regardless of whether you're long or short, the price has to move some distance in your favour before you recoup your initial trading fee. After that all gains (or losses) are yours to keep.

So, going back a few months, if you were expecting a particular company's share price to plummet, you could have shorted it and then made money all the way down. You would have to have had your wits about you to decide exactly when to open the trade and when to close it, but it could have made you a tidy profit. However, what if you didn't know which shares would go down (not all of them plummeted; some stagnated and a few even rose), but were sure that the FTSE as a whole would drop? Now we come to an increasingly popular trading tool; the spread bet.

Online Spread Betting Providers are Gaining Favour for Several Reasons

Online spread spread providers are gaining favour for several reasons. First, because any profits you make are tax-free: this activity is classed as gambling, even though you may be trading exactly the same shares as you would through a conventional tax-paying share trading account.

The second reason for spread betting's popularity is that you can trade on margin meaning that you don't have to pay for the full cost of your position exposure. You see with spread betting you aren't actually buying the shares; you are simply betting on the direction of the price of those stocks and shares. And you can bet any amount; you could bet £5 per point that Microsoft's share price will rise, or you could bet £500 per point. The more you bet per point, the faster you could make money, but also the faster you could lose it, of course.

But whereas you'd have to be a millionaire to buy sufficient Microsoft shares outright to guarantee that you'd make or lose £500 per point of price movement, you'd only need a small percentage of the total price of the shares to trade the same amount through financial spread betting. It's an exciting way to trade, but unlike a conventional share trading account, you could potentially lose more than your initial deposit.

And the other important factor with spread betting is that you're not limited to shares. You could trade the movement of the FTSE as a whole. You could trade the price of gold, or coffee, or pork bellies, or the Nikkei index, or the Dow, or oil futures, or almost anything else that is bought and sold in high enough volumes.

You could even make money from falling house prices. Some of the spread-betting companies allow you to short the price of houses, based on future contracts, usually 3, 6 and 9 months ahead, although some may allow you to bet a year or more ahead. It may not be worth doing so, however. For a start, the spreads are huge, so you're instantly facing a major loss as soon as you open your trade. And second, you usually only have the choice of 'UK' or 'London', measured using one of the main house price indices such as the Halifax.

So even if you know for sure that house prices are falling in your neck of the woods, you can't capitalise on this unless they're also falling across the UK as a whole (or all of London, if that's where you live). For anyone seeking to hedge against the falling value of their house, this is probably not the way to do it.

But there are plenty of things worth trading, either short or long. It's unlikely that the world's stock markets have completely recovered yet, because there is almost certainly more bad news to emerge from financial companies over the coming weeks and months. So you can expect plenty of volatility, during which you could potentially make money on both the ups and the downs. Or lose it.