The Pros and Cons of Commodity Trading

The Pros and Cons of Commodity Trading
  • Opening Intro -

    Dealing with commodities comes with some advantages and disadvantages.

    Investing in commodity refers to trading in assets like oil, gold, silver, copper, and other precious metals.

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There are various methods to do it, such as investing in commodity-based mutual funds, futures contracts, or buying physical assets (like a bar of gold).

There are many pros and cons of the commodities markets – it’s both a high-risk and a high-reward investment, offering a better opportunity to make a profit, while on the other hand, having too many commodity investments can sometimes be dangerous. Investing in commodities differs from other types of investments, such as bonds and stocks. It is usually carried out as futures contracts on a commodities exchange market. If you’re interested in commodity trading, let’s see all the ups and downs of the trade, before you embark on this path.

Immense pool of possibilities

Commodity trading is a viable option for diversifying your portfolio beyond traditional securities. In the past, investors used to avoid getting involved in the commodity market due to many requirements, such as money, time, and expertise (which is no longer the case). Even non-professional, average traders choose commodity trading and engage in transactions of raw and primary materials.

There are many commodity exchanges across the world, with markets being both physical and virtual spaces that feature either a single commodity or a few different ones. Commodities also fall into several categories: livestock and meat, agricultural goods, and metals. Thus, you need to do your own research and find the most suitable commodity exchange to get involved with.

Futures contracts

There are multiple routes to the commodity market, and a futures contract is one of the most popular ways to do it. In a nutshell, a futures contract is a written agreement which specifies (ahead of time) the amount and type of commodity that will be bought or sold. Speculators, institutional users, and commercial parties use them for every category of commodity.

On the other hand, service providers and manufacturers utilize futures contracts to mitigate cash-flow hiccups and outline budgeting processes. Taking advantage of these contracts requires a brokerage account first, and the leverage could bring you major profits. The downside is that the leverage represents a double-edged sword, while the volatility of markets makes direct commodity investments quite risky.

Twists and turns

Commodity exchanges are, most often, subject to agreed-upon standards. These standards facilitate the basic supply and demand principles, as well as transactions, with stable and predictable prices. There can be major disruptions in the supply and spikes in the prices, which depends on the type of commodity. Some of them display more stability than others, and it’s not exactly uncommon.

Take gold for example, it’s a reliable material with conveyable value, and can even serve as a buffer against devaluation and inflation. On the other hand, energy trading is a completely different story. Because it’s more susceptible to upward/downward surges when reacting to volatile global outputs.

Prices of major commodities constantly fluctuate due to the economic downturn, production changes, technological advances, and ever-shifting demand. Commodities, such as agricultural products, are also affected by the population growth, weather conditions, and other unpredictable factors.

Other approaches to commodity trading

If direct commodity trading doesn’t appeal to you, you can choose exchange-traded notes (ETNs) and exchange-traded funds (ETFs). Simply put, you don’t need to invest directly in contracts, but just capitalize on the commodity price fluctuations. This means that commodities trade like stocks, without management and redemption fees attached. However, there could be a discrepancy between the underlying ETNs or ETFs and market transactions.

You can also opt for copy trading via a social trading platform, which allows you invest a portion of your funds into the account of the copied investor, with all of their trading actions being copied to your account. As a copying trader, you retain the ability to disconnect your copied trades and manage them yourself.

Investing via index funds and mutual funds is another type of an indirect approach to commodity trading. They don’t invest in commodities directly, but rather stocks of companies in commodity-related industries (e.g. mining). The downsides are the non-pure play on prices and high management fees.

A commodity futures contract is the most direct approach to commodity trading, but not necessarily the safest one. Both rewards and risks are high, so if you’re a newcomer to this world, you should always tread carefully. You should rely on your analytic skills, number-crunching, due diligence, and knowledge.

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Last update on 2017-11-16 / Affiliate links / Images from Amazon Product Advertising API

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