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What are Commodities and how can can I trade commodities
What is a commodity? ans : Raw materials and also currencies which are still traded in an open outcry market futures exchange. You can trade commodities through an online broker.
Commodities futures trading involves speculating on the price of a raw material, currency or "commodity" going up or down in the future. |
These days commodities are traded between world investors all trying to buy a commodity at a low price and selling at a higher price by using commodites trading strategies and commodity trading systems. These days investors can gain access to markets via live online trading platforms for commodities daytrading.
Commodity futures trading is speculative "paper" investing, i.e. it is rare for the investors to actually hold the physical commodity, just a piece of paper known as a futures contract. Because of commodities online trading systems traders dont even need to hold the paper futures contacts.
What is a Futures Contract?A futures contract is made when buying futures in a specific commodity for a set term - the contract has an expiration date. You don"t have to hold the contract until it expires. You can cancel it anytime you like. Many futures daytraders only hold their contracts for a few hours - or even minutes!
Expiration dates vary between commodities and you have to choose which contract fits your market objective.
For example, say todays date is June 30th and you think Gold will rise in price until mid-August. The Gold contracts on LME - London Metals Exchange are available in two monthly periods - ie February, April, June, August, October and December. You would probably choose the August, October or December contracts depending on the time frame that meets your objective.
Contracts are usually more liquid nearer to expiration, i.e. there are more traders trading them. Therefore, prices are more true and less likely to jump from one extreme to the other. But if you thought the price of gold would rise until September, you would choose a contract that is "further-out" (October in this case).
There is no limit on the number of contracts you can trade (within reason - there must be enough buyers or sellers to trade with you.) Many larger traders/investment companies/banks etc. may trade thousands of contracts at a time and smaller commodity investors are able to jump in and out of markets by day trading online.
All futures contracts are standardised in that they all hold a specified amount and quality of a commodity. For example, a Pork Bellies futures contract (PB) holds 40,000lbs of pork bellies of a certain size; a Gold futures contract (GC) holds 100 troy ounces of 24 carat gold; and a Crude Oil futures contract holds 1000 barrels of crude oil of a certain quality.
A Short History of Futures TradingBefore Futures Trading came about, any producer of a commodity (e.g. a farmer growing wheat or corn) found himself at the mercy of a dealer when it came to selling his product. The system needed to be legalised in order that a specified amount and quality of product could be traded between producers and dealers at a specified date.
Contracts were drawn up between the two parties specifying a certain amount and quality of a commodity that would be delivered in a particular month...
...Futures trading had begun!
In 1878, a central dealing facility was opened in Chicago, USA where farmers and dealers could deal in "spot" grain, i.e., immediately deliver their wheat crop for a cash settlement. Futures trading evolved as farmers and dealers committed to buying and selling future exchanges of the commodity. For example, a dealer would agree to buy 5,000 bushels of a specified quality of wheat from the farmer in June the following year, for a specified price. The farmer knew how much he would be paid in advance, and the dealer knew his costs.
Until twenty years ago, futures markets consisted of only a few farm products, but now they have been joined by a huge number of tradable "commodities". As well as metals like gold, silver and platinum; livestock like pork bellies and cattle; energies like crude oil and natural gas; foodstuffs like coffee and orange juice; and industrials like lumber and cotton, modern futures markets include a wide range of interest-rate instruments, currencies, stocks and other indices such as the Dow Jones, Nasdaq and S&P 500.
Who Trades Futures?It didn"t take long for businessmen to realise the lucrative investment opportunities available in these markets. They didn"t have to buy or sell the ACTUAL commodity (wheat or corn, etc.), just the paper-contract that held the commodity. As long as they exited the contract before the delivery date, the investment would be purely a paper one. This was the start of futures trading speculation and investment, and today, around 97% of futures trading is done by speculators.
Hedging in the futures market - There are two main types of Futures trader: "hedgers" and "speculators".
A hedger is a producer of the commodity (e.g. a farmer, an oil company, a mining company) who trades a futures contract to protect himself from future price changes in his product.
For example, if a farmer thinks the price of wheat is going to fall by harvest time, he can sell a futures contract in wheat. (You can enter a trade by selling a futures contract first, and then exit the trade later by buying it.) That way, if the cash price of wheat does fall by harvest time, costing the farmer money, he will make back the cash-loss by profiting on the short-sale of the futures contract. He "sold" at a high price and exited the contract by "buying" at a lower price a few months later, therefore making a profit on the futures trade.
Other hedgers of futures contracts include banks, insurance companies and pension fund companies who use futures to hedge against any fluctuations in the cash price of their products at future dates.
Speculating in the futures market - Speculators include independent floor traders and private investors. Usually, they don"t have any connection with the cash commodity and simply try to (a) make a profit buying a futures contract they expect to rise in price or (b) sell a futures contract they expect to fall in price.
In other words, they invest in futures in the same way they might invest in stocks and shares - but by using online day trading commodities strategies.
The Advantages of Trading FuturesTrading futures contracts have several advantages over other investments:
1. Futures are highly leveraged investments. To "own" commodities futures contracts an investor only has to put up a small fraction of the value of the contract (usually around 10%) as "margin". In other words, the investor can trade a much larger amount of the commodity than if he bought it outright, so if he has predicted the market movement correctly, his profits will be multiplied (ten-fold on a 10% deposit). This is an excellent return compared to buying a physical commodity like gold bars, coins or mining stocks.
The margin required to hold a futures contract is not a down payment but a form of security bond. If the market goes against the trader"s position, he may lose some, all, or possibly more than the margin he has put up. But if the market goes with the trader"s position, he makes a profit and he gets his margin back.
For example, say you believe gold in undervalued and you think prices will rise. You have £3000 to invest - enough to purchase:
Two months later, gold has rocketed 20%. Your 10 ounces of gold and your company shares would now be worth £3600 - a £600 profit; 20% of £3000. But your futures contracts are now worth a staggering £72,000 - 20% up on £60,000.
Instead of a measly £600 profit, you"ve made a massive £12,000 profit!
2. Speculating with futures contracts is basically a paper investment. You don"t have to literally store 3 tons of gold in your garden shed, 15,000 litres of orange juice in your driveway, or have 500 live hogs running around your back garden!
The commodity traded in the contract is only exchanged on the rare occasions when delivery of the contract takes place (i.e. between producers and dealers - the "hedgers" mentioned earlier on). In the case of a speculator (such as yourself), a futures trade is purely a paper transaction and the term "contract" is only used mainly because of the expiration date being similar to a "contract".
3. An investor can make money more quickly on a futures trade. Firstly, because he is trading with around ten-times as much of the commodity secured with his margin, and secondly, because futures markets tend to move more quickly than cash markets however an investor can lose money more quickly if his judgement is incorrect, although losses can be minimised with Stop-Loss Orders. Trading methods should include placing stop-loss orders. There are packages available for online commodities trading & day trading software for commodity traders
4. Futures trading markets are usually fairer than other markets (like stocks and shares) because it is harder to get "inside information". The open out-cry trading pits -- lots of men in yellow jackets waving their hands in the air shouting "Buy! Buy!" or "Sell! Sell!" -- offers a very public, efficient market place. Also, any official market reports are released at the end of a trading session so everyone has a chance to take them into account before trading begins again the following day.
5. Most futures markets are very liquid, i.e. there are huge amounts of contracts traded every day. This ensures that market orders can be placed very quickly as there are always buyers and sellers of a commodity. For this reason, it is unusual for prices to suddenly jump to a completely different level, especially on the nearer contracts (those which will expire in the next few weeks or months).
6. Commission charges are small compared to other investments and are paid after the position has ended.
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