In the live futures markets, a trader has two basic options: buy or sell. When you buy a futures contract, you are ‘buying’ the market in the hope that prices will rise. For most people, this is the traditional, counterintuitive method of investing capital.
But what does abbreviating a futures contract mean? Read on to learn more about when selling futures contracts might be your best course of action.
buy vs sell
Here is a quick look at the buying and selling jobs:
When you buy a commodity futures contract, you commit to taking possession of an underlying asset at a future date in time. For example, if you buy a single batch of West Texas Intermediate (WTI) crude oil, you are obligating to receive 1,000 barrels of oil when the contract expires. If prices rise above your entry point, you are in a position to profit, but if they fall, an unrealized loss is created.
In the event that you sell a commodity future contract, you undertake to produce a certain amount of the underlying asset when the contract expires. To illustrate, suppose you sold 1 share of WTI crude oil. This means that you are on the hook to produce 1,000 barrels of WTI when the contract is settled. If prices fall below the contractual purchase price, you are in a position to make a profit, but if they rise, you are liable for an unrealized loss.
As you can see, the dichotomy of buying and selling is broad. On the buy side of the equation, the goal is simple: buy low and sell high. The selling side is a bit more complicated. Let’s take a closer look at what it means to short a futures contract and detail some of the strategic implications.
What does shorting futures contracts mean?
From a functional point of view, traders have several reasons to sell or “short” a future contract:
- Exit from a long position: Traders can use sell orders to offset buy orders and exit long open positions. They are usually set as profit targets (above the entry level) and stop losses (below the entry point).
- Safe bear market exposure: When you are net static and send a market sell order or sell limit order to the exchange, you are actively selling the market. This is a bearish strategy and ensures that the market is exposed to the downside. As long as the price drops below the trade entry point, you win – it’s that simple.
Strategically, there are a whole lot of reasons to go short in the futures market. Here are the most common ones:
- resistance: A common method of short selling in the commodity futures market is to sell a valid resistance level. Common resistance levels are Fibonacci Expansions, Bollinger Bands, and Pivot Points.
- Next trend: Futures traders frequently sell contracts to enter a downtrend. By selling dips in the market, you can try to take profit from falling prices. One way to achieve this goal is to sell from the 38% or 62% Fibonacci retracement levels.
- The basics: Sometimes, the underlying picture suggests that a short deal is justified. Breaking news, economic data releases or geopolitical events are some of the fundamentals that can produce strong sell signals.
So what does short selling a futures contract mean? Simply put, this means exiting a long position or getting a bearish exposure to the market. And that’s one of the great things about futures trading: flexibility.
In other products, such as stocks, mutual funds and ETFs, it is difficult to get direct market exposure on the short side. High spreads, maintenance fees, day trader style rules, and tracking errors make it difficult for retail traders to get direct downside exposure. This greatly limits the strategic choices of traders and reduces the potential for making money.
Which is better: buy or sell?
When actively trading futures, the best deal is always a profitable trade. No matter what you do – be it buying or selling – approaching the market with discipline and structure are the keys to making your trades profitable.
To learn more about the ins and outs of technical analysis, check out our free StoneX e-book Technical analysis for beginners. In it you will find useful tips for getting started with futures and taking your analysis to the next level. Make sure to download your free copy before making another deal!