by Amanda Harvey
Considering Trading Commodities?
Commodities trading is a form of trading that is considered fairly risky. In a generally volatile market, the potential for sizable gains as well as substantial losses is a reality that investors must be aware of. It is generally recommended that an investor uses no more than 10% of their investment capital on trading commodities.
What Are Commodities?
Prior to commencing commodities trading, it is necessary to understand certain aspects of commodities and the commodity market. The dictionary answer to the basic question, ‘what are commodities?’ states that ‘a commodity is a raw material or primary agricultural product that can be bought and sold, such as copper or coffee’.
In respect to commodities trading, there are four basic categories which tradable commodities fall into. These are Energy, which includes natural gas and crude oil, Metal, including gold and silver, Agricultural, which comprises crops such as coffee, sugar, cotton, and rice, and Livestock and Meat. Commodities trading has a long and colorful history, and it is claimed that trading rice futures may have started more than 6000 years ago in China.
There are three criteria which a product must meet in order to qualify as a trading commodity. It must be standardized, it must be useable upon delivery, and it must offer enough of a price variation to warrant creating a market.
Methods of Trading Commodities
The most popular way of commodities trading is on the futures markets. A futures contract states that the buyer will receive a certain amount of the commodity at an agreed upon future date at an arranged price. In an arena that is particularly vulnerable to external factors such as weather and politics, these futures contracts provide a certain amount of price stability for both the producer and the buyer.
Commodities trading provides an avenue for traders to capitalize on their accurate predictions about a certain commodity. If a trader purchases an agricultural commodity prior to major damage being sustained by those crops, the prices will almost certainly be driven up, resulting in a gain for the trader.
Commodities trading is also conducted as a means of hedging, which means buying commodities futures to protect against predicted price movement that would impact the futures contract buyer’s business. Airlines provide a great example of commodities trading as a means of hedging, as they must secure huge amounts of oil whilst protecting themselves as best as possible against dramatic movements in oil prices.
The Big Picture of Trading Commodities
Commodities are an integral part of all our lives, and as such, they will never be obsolete. Commodities’ trading provides liquidity and stability on commodities exchanges, which can not only benefit the trader, but also producers, manufacturers, other companies, consumers, and the general economy.
While commodities trading has certain risks that need to be considered, and this type of trading should be used as part of a balanced portfolio of investments, there are also advantages available in the commodities market for the astute trader.