How to trade commodities is a question that comes up quite quickly when people start to be interested in commodities and not without reason. Trading commodities can be done in different ways, all depending on the time spent and risk taken.
One of the first thing to take into consideration when looking into commodities, is that they are traded, seldom invested in. Due to the nature of the commodities markets, investing is not possible except through funds. Nobody buys a futures contract and then waits for the kids to go to college.
This means that anyone interested in making money in the commodities markets needs to know how to trade commodities, and know it well. Any market participation calls for some knowledge of what is going on, but the commodities markets demand a more thorough knowledge on how they work and how to trade them.
This article will give an overview on the various possibilities of how to trade commodities. Each possibility possesses a different mixture of risk and profitability, with more risk increasing the possible profit.
The most common ways to trade commodities is through commodity futures trading and commodity options trading. Other possibilities are various funds, such as commodity index funds or commodity etf’s.
Commodity futures trading
Commodity futures trading is the most common trading method for those interested in trading commodities. This also gives the biggest profit potential with a high risk factor.
The reason for the tremendous profitability in commodity futures trading, is the use of leverage. This means that the trader only has to put up a small part of the total price of the commodity traded. This can be around 14% of the total price, making it possible for a trader to control a commodity of 100.000 USD for as little as 1.400 USD.
The use of leverage is also the reason why individuals can loose more money than they put into the trade. Commodity futures trading is a high risk activity and extreme care should be taken before any trading is done.
I is well advised for anyone that is interested in trading commodity futures, that he spends good time in studying before he starts trading. There are several courses available online, such as Rockwell’s trading home study course.
Commodity options trading
Commodity options trading is a way to trade commodities with lower risk factor, but at the same time giving lower profit potential. Though the risk is less, it does not mean the risk is not to be found.. All trading involves a certain element of risk and the commodity options trading is no exception to that.
Commodity options trading involves buying options on futures contracts and is therefore with a high correlation factor to commodity futures market. In its simplest form, a buying or selling of an option gives the owner the right to buy or sell the underlying commodity futures contract at a pre agreed price.
Commodity etf’s or commodity exchange traded funds, are a way for individuals to participate in the commodity markets without having to cut of from the stock trading environment.
Even though the etf’s commonly follow a certain commodity, the price of the commodity etf’s does not necessarily follow the price of the commodity. This is due to the fact that the etf is an independent contract that has a certain value in it self.
Though less risky than options or futures contracts, the etf’s are not without risk. Trading commodity etf’s still requires the trader to know what he’s doing.
There are several ways to get supporting information on etf’s trading, one being f.ex. Chris Vermeulen’s etf’s newsletter.
Commodity index funds
Commodity index funds are probably the most easy way to participate in the commodities markets and offer the lowest risk factor, though they’re not risk free.
Commodity index funds are usually set up around a number of various commodities, either within a certain croup of commodities or distributed through the most traded or popular commodities.
While offering a lower risk factor, the fact that index funds follow the price movements of commodity futures contracts from the long side only, makes it difficult or actually impossible to trade the markets from the short side and thus limiting the profit potential, making it rather pointless to invest in such funds when the general trend is stable or falling.
Just be mindful that while the methods mentioned here differ in risk, they are not risk free. We recommend that you click on the various links and read a more thorough description of the possible trading methods.