You can often tell the trading sophistication of someone by their market bias. If they are always looking at the long side, in other words, always wanting to buy, they are probably new to the game. There's many stock traders who don't know what "selling short" means. Read on to see why you need to sell short to prosper, especially when trading commodity futures and for writing options.
I was talking with a commodity broker friend of mine today. He was complaining that the futures markets were relentless in their recent decline and hurting his clients. Indeed, the commodity markets in general were having a mini bear market after a spectacular advance. I asked him what percentage of his clients were short and making money on the decline. He responded in surprise, “short?!!” He thought for a bit and said one client held a wheat put while the rest of his nearly one million dollar book were long. Ninety-nine percent of his commodity clients were long! Therein lies the problem.
As we all know, for every long position there is a short position in the commodity futures and option markets. It’s a zero sum game. There were short traders on the other side of every position these clients held. Many were probably jumping up and down for joy as the market declined!
It pays to check your own bull and bear bias often. There are times to be mostly long or mostly short-biased during the middle and end of big moves. But to be mostly long after a relentless commodity bear decline is evidence of a problem. It shows holding onto losses despite obvious market evidence. After a large move up of any time frame, it is prudent to start liquidating some of the position, get totally flat or even consider the short side.
Holding long futures options that are eroding can also lull traders into big losses. The common response is, " I can't sell out here! - I still have plenty of time!" (time to hope for a miracle?)
When the time to option expiration finally arrives, the harsh reality sets in.
The moral is, the moment you realize you are wrong, start liquidating.
Part Two of Two Parts - Next!
There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.
