First of all, let’s understand what short and long are. When a trader opens a long position, he buys an asset in the hope that its price will rise. The investor needs to buy the asset in the financial market and then sell it at a higher price to profit from the difference between the buy and sell. If the price of the asset does increase, the trader sells the asset at the higher price and makes a profit. For example, if a trader bought one bitcoin at $30,000 per coin and then sold it at $31,000, the profit would be $1,000.
The opposite concept to long is short. In this case, a trader sells an asset that he believes will be worth less in the future. He does this because he expects the price of this asset to decrease. In other words, the investor takes an asset on credit from a broker and sells it on the market in the hope of buying it back at a lower price and returning it back to the broker. The difference between the sale price and the redemption price becomes the trader’s profit. For example, if a trader sold bitcoin at $30,000 per coin and then buys it back at $29,000, the profit will be the same $1,000.
It would seem that everything is quite clear, but in practice, beginners sometimes do not fully understand the difference between short and long trading and regular buying and selling. Let’s try to understand it.
Spot and margin market
The spot market, also known as the immediate delivery market, is a market in which commodities and financial instruments are exchanged immediately, that is, the settlement of transactions and the transfer of the asset in the spot market occurs immediately after the transaction is concluded.
For example, if a trader bought bitcoin on the spot market, this bitcoin will be immediately transferred to his account and put at his full disposal and the trader can sell it, keep it on his balance or withdraw it to his wallet or other exchange.
Margin market is a financial market where traders can increase their positions through credit financing. In such trading, a trader must pledge a certain amount of money in his account (known as margin collateral or margin) and then accesses credit to increase his purchasing power. The trader can use this credit to purchase assets and engage in high-volume trading, while using only a portion of his or her own funds.
For example, a trader transfers 100 dollars to a margin account. In this case, a credit becomes available to him in the amount determined by his broker or crypto exchange. It can be $1,000 (i.e. ten times his own funds, leverage 1:10) or even 10,000 (leverage 1:100).
Credit assets can only be used for trading, they cannot be withdrawn. If a trader opens a margin transaction with credit funds, he will have to return them after the transaction is closed. A broker or exchange will charge a commission for the use of credit funds.
Differences between spot and margin trading
On the spot market, normal transactions take place for the trader’s own funds. For example, a trader has replenished his balance on the exchange with rubles, but wants to trade in the BTC/USD pair. If the trader has rubles, he can only buy something in ruble pairs, other pairs are not available to him. Then he must first exchange rubles for dollars in the USD/RUB pair (or rubles for bitcoins in the BTC/RUB pair), and then start trading in the desired pair. At the same time, he can withdraw any asset from the exchange at any time. The usual terms “buy” and “sell” are applied to transactions on the spot market.
On the margin market things are a bit different. For example, on a trader’s margin balance there is a deposit of 1000 dollars. Having this collateral, he can trade in any pairs, and in both directions. For example, having dollars, he can enter a pair where bitcoin is traded against euro and buy bitcoin for euro (long) or sell bitcoin for euro (long). In this case, the broker will simply lend him a loan in the corresponding asset (bitcoin or euro), and in an amount larger than his own deposit.The borrowed funds are locked within the margin account and cannot be withdrawn.
It is for margin (and futures) trading that the concepts of short and long are characterized. As you can see, they have differences from regular spot buying and selling, although they are still related and some traders may sometimes confuse them.
Compared to the spot market, trading on margin can provide traders with greater opportunities to increase their potential profits, but it also increases the risk of loss because it is leveraged and requires good money management.
For example, if a trader is trading with a leverage of 1:10, this means that when he opens a position of $1,000, he will be using $900 of leverage. A rise in this position by just 10% will earn $100, doubling the initial deposit, but a fall of the same 10% will result in a complete loss of the initial deposit. In addition, holding a large margin position for a long period of time can lead to large spending on borrowing fees, this should be taken into account when starting to trade on margin.
Thus, spot trading is considered to be more reliable and safer than short and long margin trading, and beginners at the initial stage are recommended to pay more attention to spot trading or trading with small leverage (not more than 1:3 or even 1:2) to work out their trading strategies, capital and risk management.