Trading Down A One-Way Street - Conclusion
...Continued From Part One
We All Love The Bull
Itís true that most of us love to be long. It's just a simple fact of human nature. We all look back fondly on the last significant market rally and assume that it will happen again soon. While this attitude may feel natural to us, it is hardly the best attitude for successful trading.
If you can manage it, the best trading attitude is to be neither bullish nor bearish on the overall general commodity market. Let each commodity stand on its own individual merits. You should be flexible enough to be bullish on gold and bearish on silver at the same time. Alternatively, you can bullish on wheat and bearish on soybeans if that's the forecast. It's all up to you.
Know When To Split A Pair
It's true that most of the time these particular commodity markets move together. However, the true test of a flexible, clear-headed trader is the ability to split closely related futures markets. If your comfort level allows it, it is advisable to have at least a few short positions in your accounts at any given time. When you go long three attractive markets, try to find at least one market to short. A good idea is to look for the weakest commodity market to short after a rally.
It may sound trivial and clichÈ, but remember to always sell on rallies and buy on dips. The futures market usually gives you many chances to get on board when a move is in its early stages. Once the move progresses, the corrections are usually brief, shallow and difficult to enter without high risk.
Separating The Men From The Boys
Trading short is the mark of a true options/futures professional. Futures markets generally fall twice as fast as they rally. Most experts believe that this is because it takes time for the public to gain enough confidence in join a rally. On the flip side, as we've seen over the past few weeks, fear can be almost instantaneous and generate substantial crashes.
The one difference between commodity and equity panics is the shortage factor. If a commodity market is experiencing a perceived shortage, then it will frequently form a fast spike to the top. This is far more rare in equities, where shortages usually do not occur. The one exception is a short-covering panic, which can occur in both markets.
Don't Let Your Fear Rule You
Don't let fear keep you from shorting an over-priced commodity future or option. The notion that losses on short positions are unlimited is a common excuse that prevents novices from going short.
However, holding a long position through a 2-3% adverse price move is not a good idea in any environment, let alone holding a short position through an adverse upside spike. If you're afraid to go short, then use stops and limits to control your risk profile. That way, you can cut your losses long before they reach the infinite level.
At the end of the day, all traders should be just as willing to trade short as to trade long. If you're not comfortable trading short, then you are cutting out half of your arsenal. In all my years in the market, I've never known a trader that became successful with one hand tied behind his back!
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