Commodity Trading - Advantages and Disadvantages

Home
>
Currency Trading
>
Commodity Trading - Advantages and Disadvantages

Commodity Trading - Advantages and Disadvantages

What Is Commodity Trading?

Commodity futures markets allow commercial producers and commercial consumers to offset the risk of adverse future price movements in the commodities that they are selling or buying.

In order to work a futures contract must be standardised. They must have a standard size and grade, expire on a certain date and have a preset tick size. For example, corn futures trading at the Chicago Board of Trade are for 5000 bushels with a minimum tick size of 1/4cent/bushel ($12.50/contract).

A farmer may have a field of corn and in order to hedge against the possibility of corn prices dropping before the harvest he might sell corn futures. He has locked in the current price, if corn prices fall he makes a profit from the futures contracts to offset the loss on the actual corn. On the other hand, a consumer such as Kellogg may buy corn futures in order to protect against a rise in the cost of corn.

In order to facilitate a liquid market so that producers and consumers can freely buy and sell contracts , exchanges encourage speculators. The speculators objective is to make a profit from taking on the risk of price fluctuation that the commercial users do not want. The rewards for speculators can be very large precisely because there is a substantial risk of loss.

Advantages of commodity trading

Leverage. Commodity futures operate on margin, meaning that to take a position only a fraction of the total value needs to be available in cash in the trading account.

Commission Costs. It is a lot cheaper to buy/sell one futures contract than to buy/sell the underlying instrument. For example, one full size S&P500 contract is currently worth in excess off $250,000 and could be bought/sold for as little as $20. The expense of buying/selling $250,000 could be $2,500+.

Liquidity. The involvement of speculators means that futures contracts are reasonably liquid. However, how liquid depends on the actual contract being traded. Electronically traded contracts, such as the e-mini's tend to be the most liquid whereas the pit traded commodities like corn, orange juice etc are not so readily available to the retail trader and are more expensive to trade in terms of commission and spread.

Ability to go short. Futures contracts can be sold as easily as they are bought enabling a speculator to profit from falling markets as well as rising ones. There is no 'uptick rule' for example like there is with stocks.

No 'Time Decay'. Options suffer from time decay because the closer they come to expiry the less time there is for the option to come into the money. Commodity futures do not suffer from this as they are not anticipating a particular strike price at expiry.

Disadvantages of commodity trading

Leverage. Can be a double edged sword. Low margin requirements can encourage poor money management, leading to excessive risk taking. Not only are profits enhanced but so are losses!

Speed of trading. Traditionally commodities are pit traded and in order to trade a speculator would need to contact a broker by telephone to place the order who then transmits that order to the pit to be executed. Once the trade is filled the pit trader informs the broker who then then informs his client. This can take some take and the risk of slippage occurring can be high. Online futures trading can help to reduce this time by providing the client with a direct link to an electronic exchange.

You might find a truck of corn on your doorstep! Actually, most futures contracts are not deliverable and are cash settled at expiry. However some, like corn, are deliverable although you will get plenty of warning and opportunity to close out a position before the truck turns up.

Tim Wreford operates Online Futures Trading, a website that provides information and resources for traders. Tim also provides an article detailing the development of a day trading system, the results of which are updated daily on the site.

In The News:

'Ghastly' Venice bus crash leaves unanswered questions as tourist city mourns 'unbearable tragedy'
Wed, 04 Oct 2023 19:21:00 +0100
We are standing on the side of a flyover, looking over the edge, and it is a fearful sight.

US hands Ukraine more than a million rounds of ammunition it seized from Iranian ship
Wed, 04 Oct 2023 20:08:00 +0100
The United States has sent over a million rounds of ammunition it seized from an Iranian ship last December to Ukraine.

Teen girl 'in coma' after 'attack by Iranian police for not wearing hijab'
Wed, 04 Oct 2023 19:01:00 +0100
A teenage girl is in a coma after she was "physically attacked" by Iranian authorities for not wearing a hijab, according to a human rights group.

FIFA considering lifting blanket ban on Russia competing in international football
Wed, 04 Oct 2023 11:10:00 +0100
FIFA is looking at ending Russia's blanket ban from international football, Sky News understands.

Eurostar on alert as Paris grapples with bed bug infestation
Wed, 04 Oct 2023 21:12:00 +0100
Eurostar staff are on alert due to a bed bug infestation in Paris, which has hit the French capital in recent days.

tikatoshop.it

Erfahrungen mit Pallhuber Wein
Agen Bola SBOBET Terpercaya

Travel in comfort and at your leisure with CT Airlink Limousine & Car Service for top quality private transportation and exceptional customer service. We operate Sedans, SUVs & Vans for CT Car Services to covering all Connecticut airports including Car Service from CT to Newark Airport , Mohegan Casino Uncasville CT, Foxwoods Casino Mashantucket CT, Manhattan Cruise Terminal NYC, Brooklyn Cruise Terminal NYC and Bayonne Cruise Terminal NJ. CT Airlink hire licensed and friendly chauffeurs who have in-depth knowledge of the Areas.