Commodity Trading Basics: Going Long vs. Going Short

Rule number one in trading commodity futures: You have to realize that trading is a zero-sum game. For every winner, there is a loser. Think about it: You’re on one side of the trade, and if it’s going well, you’re making money. At the same time, the person who is opposite your trade (they’re short if you’re long or they’re long if you’re short) is losing money as fast as you’re making it. Although this sounds harsh and pretty cut-and-dry, it is what it is. If you have any feelings of guilt or remorse about the fact that while you’re making money there is someone else simultaneously losing money, you might want to consider another field of endeavor besides commodity futures trading. There are exceptions to this, however, such as when people are trading spreads and so forth (a whole other topic to get into), so there are times when it’s simply considered part of the expense of trading. For instance, if I wanted to enter the Copper market and go long, I might buy a put option with a strike price that’s at or near my entry price, and use it as a hedge just in case the market moves against me early on. Let’s say that the market completely takes off, and my put option expires completely worthless…not a problem, I’m making money due to the long futures contract, and the put option was there for “insurance purposes” anyway; any losses sustained from the put option will (hopefully) be offset by the gains in the futures contract. Well, the guy that wrote the put (the person who is opposite my position) will be happy, because he was able to collect the full premium that I paid for that option, being that it expired worthless, and I’m happy too, because I have just racked up some serious profits on the long side of Copper. We both win. So, in cases like this, the “zero-sum” rule is somewhat subjective. As far as my futures contract goes, however, yes indeed, there is someone losing money while I’m making money. At the end of the day, that’s just the nature of the beast.

Speaking of the terms “long” and “short”, I guess it would be good for me to explain what they mean to anyone that is not fully familiar with commodity futures trading. Basically, when people say “I’m long Coffee”, or “I’m going long Oats”, they simply mean that they’re buying a futures contract on that particular commodity, in hopes of prices going higher. For example, you may buy a Corn contract and enter the market at 275.00, and then the market jumps in price to 310.00. You have made money in this scenario because you were “long Corn”. I know it seems like incorrect grammar to say it that way, but that’s how the lingo goes. “Long” is the most common trading position in most people’s minds, and for some reason (possibly conditioning from the media and so forth), it seems to be the only acceptable position. The reason why I say this is because we are commonly led to believe that when a market drops, it’s a bad thing. Let me tell you, if you are short in a market and the market drops, you are celebrating. “Going short” simply means that you are selling a futures contract in expectation of prices declining. One of the first questions people normally ask is this: “How can I sell something I don’t own?” Well, to be honest, I’m not sure I fully understand how going short works, but I sure have made some money shorting all kinds of markets. In short form, you are basically “borrowing” a futures contract from the brokerage, selling it at a set price, and then waiting for the value of the contract to drop so that you can turn right back around and buy that same contract back with the proceeds from the sale of the contract that was credited to your account when you entered the trade. Once you buy it back (which will close out your position), you pocket the difference in price between the time you sold it and the time that you bought it back (or, closed out the position). It’s funny because I know that this is totally not the best definition of going short, and if you’re still confused about it, I understand why, but that just goes to show you that you don’t even have to have a full grasp of the concept of going short in order to make money shorting the markets. Again, although the world of trading commodity futures is hairy and complex, if you keep it what I like to call “dumb country simple”, you’ll do much better than trying to over-analyze every nuance of the markets. The K.I.S.S. principle (Keep It Simple, Stupid) definitely applies here. As I said earlier, I’m still not exactly sure how it works, but I have made money many times going short. To keep things extremely simple, if you enter a market on the short side (i.e., if you “go short”), as long as the market is dropping in price, you’re doing great. If you don’t remember anything else when trading commodity futures, remember that. When you’re long and prices go up, you’re golden. When you’re short and prices go down, you’re golden. It really is that simple.