We may all know by now that commodities – food, energy, and metals – are very important in our everyday life. But how well do you know commodity trading?
Today we will discuss everything you need to know about commodity trading. We will also give you some important tips and some myths that you should know about.
What is Commodity Trading?
Commodity trading moves the raw materials that are needed in everyone’s daily life from the place of production to the place of consumption.
It is an investing strategy wherein the traders trade goods instead of stocks. Commodities traded are often goods of value, consistent in quality, and produced in huge volumes by various suppliers.
Supply and demand can affect trading, since a limited supply can cause a price increase while an excess supply causes price decrease.
Just like stocks, commodities are traded on exchanges where investors work as a team to buy or trade products to generate profit from the fluctuation of market prices.
This kind of trading has a diverse industry. The trading houses of commodity trading can be small local operations of few people. It can also be a large multinational company with thousands of employees around the globe.
Meanwhile, commodity traders trade goods such as, cocoa, coffee, cereals, sugar, oil, natural gas, and precious metals. Commodity trading also comprises various companies that provide related services like shipping and logistics, inspection and certification, and insurance.
The margin of a trader, on the other hand, is quite slim compared to other industries. It is usually ranges from 0.5 percent and 3 percent and thus comparable to retail. This mean that the volumes transacted are high and the absolute revenue figures are a direct function of the volume.
Moreover, the margin is the reward of trader for the value added of transforming commodities in space, time, and form.
Types of Commodities
Commodities have four categories and they are:
In this type of commodity it includes Gold, Silver, Platinum, and Copper.
2. Livestock and Meat
This type of commodities includes lean hogs, pork bellies, live cattle, and feeder cattle.
This consists of crude oil, heating oil, natural gas, and gasoline.
Agricultural is a type of commodity that includes corn, soybeans, wheat, rice, cocoa, coffee, cotton, and sugar.
Tips of Commodity Trading
As beginner you might be looking for some tips that might help you upon entering the field of trading. Here are some tips that can guide you once you started trading in commodities.
There are a lot of times wherein traders do not invest enough time and hard work when it comes to trading. Instead, they use commodity trading as a hobby to have profitable returns from time to time. If you really want to succeed in this trading, you must work hard for it. Getting on top takes time you just need to be patient.
You should resist the temptation of over-trading. Placing a large amount of money on any single trade only means kick starting a cycle of losses. This is true especially if the commodities that are being traded are very expensive like crude oil and precious metals.
In order for you to be safe in commodity trading, you must trade within short spreads. Do this until the time you gain enough experience to be able to differentiate between genuine and false upside breaks.
Myths of Commodity Trading
There are many investors who are very reluctant to trade in commodities due to a various myths and misconceptions.
Here are some of the myths or misconceptions that you might hear or see once you started trading in commodities:
Myth #1: No One Makes Money in Commodity Trading
The truth is that a lot of investors tend to lose when trading in commodities. However, the investors who lose are the ones who are ill-prepared investors who jumped into the market and lose in the span of six months, and never return in the market.
Meanwhile, other investors get addicted to the market as they keep on trying to make a killing with the same strategies and they keep on losing.
The great news about commodity trading is that it is a zero-sum game. This mean that for every dollar lost, someone will gain a dollar. Actually, you need to factor in transaction costs, so if a person losses a little more than a dollar, the other party gains a little less than a dollar.
Now you might be wondering, who makes all the money? The answer is the professional commodity traders and money manager, who constantly makes money year after year. Amateur commodity traders are also part of investors who makes money due to trading for a long time.
Moreover, successful amateur traders and professional traders usually trade a big amount of money.
Therefore, you can make money from commodity trading whether you are a novice or an experienced investor. Yes it is true that trading in commodities is not easy, but if you work hard and do some research you will have a much better chance of succeeding.
Myth #2: There is Too Much Leverage
Leverage is one of the biggest problems when it comes to investing in commodities. You usually only have to put up about 3 percent to 15 percent of the total value of a futures contract in futures margin. That is far less than the 50 percent required for stocks.
A lot of new commodity traders do not know how to handle their newfound gift of incredible leverage. However, in reality, commodities are no more volatile than stocks as an asset class if you eliminate the leverage factor.
Meanwhile, the problem with many investors is that they will invest a $25,000 account as if it were $250,000. If you plan to purchase 10 futures contracts that have a margin of $2,500 each and $250,000 worth of commodities. Therefore, if the commodity goes up a little, you will be making $25,000, which doubles your investment. But, if the commodity moves down, your investment will be wiped out.
In order for you to succeed in commodity trading, you should trade far fewer contracts than what the margin requires.
Myth #3: You Don’t Have Enough Money to Trade
A lot of commodity brokers will let you open an account with $5,000, and some even start at $2,500. This money should be a risk capital as commodities can be a risky investment.
The problem of an account with this amount of money is that investors take on too much risk for their account size.
Just remember not to fall into that trap. If you shoot for a decent return of 25 percent a year, you will do much better in the long run as opposed to trying to hit a home run.
Myth #4: Taking Delivery of Commodities
This myth is not something you should really worry about. The commercial players are the ones who involved in taking and making delivery of commodities.
As long as you close your futures contract before the first notice day, which happened a few weeks before your contract expires, you should not worry about this myth.
However, if the forgot about the first notice day, your broker will definitely see it and will contact you immediately.
Myth #5: It is Only for Speculators
For many years, commodity trading has been part of the economy. With market participants, particularly hedgers, arbitrageurs, and speculators they helped efficient the price discovery and price-risk management.
Speculators are prepared to assume the risk, which hedgers are trying to transfer in the futures market. Meanwhile, market experts are stating that speculators add depth and liquidity to the market.
Commodity trading has some myths that made by the general public. The best thing that you need to do is do your own research.
With doing your own research, you do not just learn the truth but you will also gain some knowledge about commodity trading.
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