Truth About Commodity Trading
June 6, 2008 – 5:12 pmCommodity futures trading is an on going battle between return and risk. Because of the high amount of leverage involved, you can achieve a higher rate of return than from most other forms of investment, but at a higher risk. Commodity trading is speculative, involves a high degree of risk, and is designed only for sophisticated investors who are able to bear the loss of more than their entire investment.
You should keep in mind that past performance is not necessarily indicative of future performance. Commodity trading is just one step in solving the complex agriculture problems. Interestingly the concept of futures trading started from farming when a French wine merchant started locking prices for his wine produce even before his grapes were ready.
Commodity trading is speculating on the future price movements of basic raw materials on which global trade is based. The two most traded commodities are oil and coffee; however, all most other basic materials are also included in this market like copper, silver, gold, and wheat. Commodity trading is reaching an all-time high in popularity. Although some skilled individuals are able to make a profit with futures trading, there are also those who end up losing money. Commodity trading is a big arena, just like the stock market.
Commodity trading is a risky venture and in order to produce profits takes some sound special education and a superior trading system. Most commodity traders tend to fight the markets in an attempt to gain profits quickly only to find the market continues sideways or travels in the opposite direction. Commodity trading is based on leverage, and the power of leverage is what makes people rich. Commodity trading is the one area of the financial markets where any person with tenacity, risk capital, and discipline can be highly successful. BUT there is also the considerable risk of loss, particularly for the uneducated or misinformed.
Commodity trading is simply buying commodities (such as gold, or silver or platinum) as a tangible asset. When inflationary pressures are strong (and interest rates are low), these can give a better return on investments. Commodity trading is not inherently risky. It is only as risky as you want to make it according to the amount of leverage that you use. Commodity trading is a zero sum or cash business. Your trading account is settled at the end of each trading day with your trading account balance changing daily.
Obviously, unlike having money in a bank CD, this type of investment can lose as much or more than is gained. An advantage of using commodities is that commissions are much lower than with other types of investments, such as in mutual funds. If you run out of money as a position runs against your expectations you will be forced out of the market and will lose the lion’s share of your capital allocated for that trade. In an extreme situation, such as if corn was linked to cancer in humans, then obviously if we were long corn we would most likely get out and take a loss.
Futures trading is economically beneficial because it facilitates better production planning in the agriculture and agro-based industries. In these sectors it is also utilised as a hedging device against violent movement in the price of commodities over a period of time which, in the case of agricultural produce, stretches over crop seasons, often from sowing to harvesting time. Futures trading grew by leaps and bounds making the most of the bull-run witnessed globally. Fueled by the rally in equity markets, stock market players jumped into commodity markets to leverage on the all round boom.
Future trading includes widely traded commodities like coffee, oil, gold, sugar or financial instruments like stock market indices, bonds, or currencies. Futures and options markets are risk management tools, helping to offset the exposure of contracting to supply a given amount of commodity ahead of harvest time. The commodity exchanges in practice seem to be less a way to spread risk, and more a way to concentrate profits for those who know the most about a market.
Commodities futures contracts allow speculators the right to buy or sell a specified quantity of a commodity at a contracted price before an expiration date. Less than 3% of all futures contracts result in the physical delivery of any commodity. The vast majority of contracts are liquidated before expiration.
It is not wise to trade commodities without a good foundation of commodity market knowledge. In getting started it is best to focus on just one or two commodities. That will be enough to keep you busy for a long while.
Tags: Coffee
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