For people who are looking for ways to invest little capital and limited risk, the commodities market has always been a good choice. It has enabled numerous individuals to generate huge amounts of profit for only a limited time span. For example Richard Dennis, also known as the “Prince of the Pit” invested about $1,600 at the start of his trading career and managed to turn it to $200 million in just 10 years.
As the US economy fails to pick up, more and more traders are diversifying their portfolio to include commodity futures because of the advantages it offers. If you’re planning to hedge your risk, then it’s time to look into the commodities market, but be forewarned: it is not a get rich quick scheme. Just like the other financial markets, commodities trading also involves risk-taking. While it is fairly easy to understand and can generate enough profit in the short term, it still requires prudence and proper money management.
Trading commodities are also known as futures trading because it requires you to speculate on the future price of a particular commodity. It is like making a bet on the future price direction. The terms “buy” or “sell” merely reflects the direction you expect future commodity prices to take. For example, if your commodity of choice is corn and you’re expecting prices to go down in the next few months, then you would sell futures. If you’re expecting prices to increase, then you can buy futures.
All futures contracts involve a buyer and a seller. These market participants do not need to own the commodity, but like stock and forex trading, they must have enough capital deposited with a broker to pay for future losses in case the trade goes bad. In this case, the buyer and seller of the commodity are referred to as speculators.
Aside from the speculators, producers and consumers of the commodity may also choose to participate. In this case, the futures contract serves to enable commercial consumer’s protection from the changing prices. One side of the transaction may be a farmer who will harvest the commodity in a few months. If he is worried that prices of the commodity may go down at the time of harvest, he may choose to sell a futures contract with the size equivalent to the commodity he is able to fulfill. By doing this, price changes in the commodity will no longer matter – he will receive the price stated on the contract.
On the other side of the transaction is another producer who uses the commodity as raw material. For example, cereal manufacturers who need corn to make their product. If the firm is worried that prices may increase by harvest time, they may choose to purchase a futures contract to lock-in the price, hence, their total production cost and ensure profits.
Aside from agricultural products, traders can also trade other commodities including metal and oil. The same principle applies to all types of commodities but the strategies used in trading may vary depending on the chosen commodity.
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