Before investing in commodity futures one should be aware of the basic approaches, sometimes known as positions, to adopt. There are two basic positions for trading in commodities known as long and short positions.
Due to high volatility in commodities market, it is important for an investor to understand the difference between the long and short positions. These positions can be taken on the basis of our assumptions whether the price of commodity will go up or will move down.
Long position in commodity futures trading conveys the buying of any commodity first with the expectation of rise in value of that commodity. This can be done by entering into any commodity futures contract. To offset a long position, you need to sell the same contract before it expires. If the contract is not sold before it expires then it will result in physical delivery of the product.
You should go for 'buying long' approach when you feel that the price of commodity will appreciate in near future. The buying long strategy turns out to be profitable if the commodity appreciates in its value during the holding period of that contract.
Typically, hedgers go for long approach to hedge against the price rise. For example, if Airline company expects price of oil will rise in future, which may affect its purchases. It will go for buying long crude oil futures to hedge against the price rise.
A short position in commodity futures trading implies the selling short a commodity futures first and then offsetting by buying the same on a later date. Sell short strategy can be adopted when the expectation is that the price of commodity will decline in near future. A short position is of course opposite of a long position.
You need to enter into a futures contract if you want to sell short any commodity. The selling short position turns out to be profitable if the underlying commodity depreciates in its value during the holding period of that contract.
You may also incur loss if the resulting purchase price is greater than the original sale price. Unlike Long position, you receive the physical delivery in case you haven't squared off the future contract, in short position you will have to make the physical delivery if you do not square off the future contract.
So, its very important to analyse fundamentals before entering into short position.