When we think of trading and investment the intuitive way of trading is to buy with a view of selling in the future at a profit. This is the traditional long position and to most people, even non-traders make sense. The counter move is to go short which is in essence a prediction that the price of an asset will drop.
As you can see when it comes to short vs. long it gets a little complex. Arguably as the futures market is a contract to buy or sell a physical asset or currency for a set price in the future, the expiry date, it gets that little bit more nuanced.
This isn’t financial advice, but let’s take a deep dive into short vs long where futures markets are concerned.
Understanding Leverage and Margin where Futures is Concerned
Before we take our dive and test the depths, it is important you get your head around margin and leverage. All futures contracts run through a licensed broker. Here, when you open a position in a futures contract you pay a fee which is often a small percentage of the total contract value, say 5% for example. This is the margin.
The leverage is the contract value minus the margin. This allows you to open a position for a small outlay. The disadvantage is that should the contract lose value, you’ll be asked to pay a maintenance margin fee which corresponds to the value lost. Potentially this can be high risk.
Now you understand how futures contracts operate, let’s take a look at short vs. long.
Short vs. Long
The futures market like other types of trading, you have the option to buy or sell. When you buy a futures contract you are in most cases buying a physical asset and making a commitment to take delivery of said asset at the expiry date of the contract, say 500 barrels of oil for example. Come expiry should the price of the oil be higher than when you took out the contract, you profit. If the reverse happens and the price is lower, you make a loss.
Selling obligates you to provide the commodity of the underlying asset at the contracted price come expiry. For example, you deliver the 500 barrels of oil as per the futures contract. Should the price be lower than your sell price, you are positioned to profit, if the price has risen you make a loss.
Buying is a simple mechanism. Buy low, sell high. The selling side of futures contracts is more complicated. Let’s look at shorting and how you can profit from it.
Shorting a Futures Contract
It is crucial that you understand that when you short a futures contract you run the risk of unlimited losses should the price become volatile. Before shorting a contract ensure you know the details as well as you can and you’ve done your homework. This can’t be reiterated enough.
That said, there are several instances when the right decision to sell becomes apparent. They are:
- Terminate a Long Position – As with most trades you may have a profit target and a stop loss figure in mind. At this point, selling is arguably the right move.
- Secure a Profit in a Bearish Market – One strategy that is often used in futures that should the market be bearish and you’re position is net-flat is to use a sell limit order. As long as the price falls below the sell price you’re making a profit and effectively you are shorting the market.
As you can see the dichotomy of long vs. short is not really pitting one side against another but to analyse and understand the market and make a decision of whether to buy or sell, or in other words go long or go short. As shorting is arguably a more difficult concept let’s look at the strategies traders typically deploy:
- Trends – It is not uncommon for traders to sell if the trend of the market is bearish. They will look at the Fibonacci retracement level and sell between the 38 to 62 percent range.
- Events – Depending on the global landscape, you may decide a short position is the best option. Economic data releases, geopolitical occurrences, and breaking news all contribute to what happens in the futures market.
- Resistance – Traders use Bollinger Bands, pivot points, and Fibonacci expansions to identify a resistance point and sell accordingly.
As with all trading, the key to success with the futures market is to analyse commodities and world events and deploy recognised trading strategies. Discipline and focus are required to successfully trade. If you can master this you are in a good position.
The alternative is that you let professionals handle your futures market investments and this too can be a good move. But that is the subject of a different article.
Good luck with your futures trading.
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