Why does it matter if “the funds” or anyone else is “long” or “short” in the market?
A farmer could be forgiven for wondering that after reading through multiple market reports and seeing much ink spilled on investors’ bullish (long) and bearish (short) bets.
For example, in the last few weeks the wheat market jumped higher in a short covering rally.
Various players’ positions can seem to be confusing, but sitting in plain sight amongst the statistics on market positions are trends and positions that give hints and warnings to the canny farmer.
This year, major speculative investors, described in various ways such as “the funds,” or “managed money,” have moved into large “short” positions in many crop futures markets. Being “short” means to have sold futures, thereby winning if prices fall and losing if prices rise. Being “long” means buying futures and benefitting from the futures price rising and losing from it falling.
In recent months those funds have been betting heavily on crop prices falling and that is important in terms of the likely market trend and the way it could eventually end, analysts say.
“It changes the potential, the pricing parameter,” said Austin Damiani of Frontier Futures in Minneapolis about big overall short or long positions for speculative investors.
“If there’s a big position in the market one way or the other, then if we get some news that comes out or some catalyst changes the trend, then it creates the possibility for a larger move in the opposite direction.”
A big net position – meaning the funds are overwhelmingly either short or long – means there could be a sudden stampede if the trend reverses.
The bigger the net position, the greater the chance that a change in direction will cause a sudden and dramatic price move than if the funds had only small positions to get out of.
“The size of the position creates the potential for a large market move in the opposite direction,” said Damiani.
But large net positions aren’t necessarily a sign that a market is out of balance. DTN’s Darin Newsom said investment money, rather than farmer or commercial grain user money, has been dominating market direction for years, and especially since 2012, so the funds can take a direction and follow it steadily, thereby building up a large net position. But that’s just a symptom of the trend-making money flow.
Watching how the speculative money is flowing, which can be seen in statistics like those in the U.S. Commitment of Traders reports, can give good indications of where prices are likely to go, because trends can last for long periods.
“If you look at the trend, how a market’s moving, that gives you a good idea of what the investor is thinking,” said Newsom.
“So to me it is the key determinant of price direction, which way is this money moving.”
But while following the trend, people need to be careful to note the net positions being built up, since they create the powerful rebound potential Damiani mentioned.
“Once they start to (build up a major net position), you can almost start taking a contrarian look at this and say that at some point they are going to cover that (and probably cause the trend to reverse),” said Newsom.
“We don’t know what the trigger is going to be to cause it, but at some point they’re going to start (unwinding their large positions.)”
An example of that can be seen in recent days in wheat futures, with a major, multi-month trend of funds selling wheat futures until the end of May, amassing a major short position while the market fell, then buying-back wheat futures in the first days of June, helping cause a sharp rally. The size of the net short helped the rally storm higher than it would have if there hadn’t been such a large short position, since those taking profits and avoiding losses had much to liquidate.