Commodity Futures Trading
Commodity Futures Trading
Commodity futures trading is a type of investment where one can make money by speculating on the price of a certain commodity going up or down in the future. Commodities are usually the essential things that people make use of everyday. Most of the times, these commodities are the basic essentials needed by a modern society.
When talking about certain commodities being traded in the futures market, it must meet certain conditions to make it allowable for trading. One of the conditions is that the commodity should be standardized. In trading agricultural and industrial commodities, the traded commodity should be in its basic raw and unprocessed state. In this case, Wheat may be traded in the futures market but not flour.
Another condition that a certain commodity has to meet is that the perishable kind should have adequate shelf life. The reason for this is that these commodities are traded with their delivery scheduled deferred at a future time. Therefore, there may require a long shelf life so that the commodities may be delivered with its quality still good and intact. Another condition that a certain commodity should meet is that it should have a price that changes often, creating some uncertainty as well as opportunity to profit.
The history behind futures trading in commodities evolved from the farmer’s need to earn more from every harvest. Before commodity futures trading started, the farmers were always at the mercy of the dealer when it comes to pricing and selling their harvests. Dealers usually set the prices and the farmers cannot to anything but accept the terms. In a way the farmers were being exploited by some dealers and so another form of selling their harvest.
In the search for having a more fair system of doing business, farmers began offering future harvest to interested buyers. The farmers started giving their own terms for the future harvests to dealers. The transaction consists of commodities offered as a certain price and to be delivered as a specified date. Contracts were then drawn up between the farmer and the interested buyer that specified the certain amount of commodity to be delivered at a particular time in the future. From this system, what is now known as futures trading has begun.
It was sometime in 1878 that a central dealing facility for such commodities contracts was established in Chicago. In this facility, farmers and dealers began initially in spot dealing of their grains that was immediately delivered upon a reached settlement in price. It eventually evolved into futures trading when farmers started committing future harvests to interested dealers willing to buy to ensure that their grains supply are maintained in the future.
In the beginning, futures trading initially consists only of a few farm commodities such as grains. But later on, a huge number of other commodities joined in. Now there are futures trading markets that deal in precious metals such as gold, silver and platinum. There is also a futures trading market for livestock and cattle as well as for energy products such as crude oil and natural gas. It has gone on to include futures trading in coffee, orange juice ad industrials such as lumber, cotton and even on interest rate bearing instruments such as currencies and stocks.
Futures Investment
Futures trading can be an attractive investment option for some people. It is a type of investment where investors try to take advantage of trading futures contracts. These are contracts that are made by producers of a certain commodity with a dealer which involves the obligation of delivering a certain amount of a certain commodity for a specified period of time in the future. The commodities that such futures contracts trade can include grains such as wheat, corn to other produce such as lumber, livestock, cattle, coffee and even orange juice. There are also futures contracts for precious metals such as gold, silver and platinum.
What makes futures trading quite attractive is the high level of investment leverage that it offers. Investors can invest just as little as ten percent of a futures contract’s value in order to have the opportunity to trade it. This allows investors to trade futures contracts using lesser investment capital for trading larger valued contracts.
Futures contracts usually have standardized amounts of the commodity that they involve. For example, if an investor holds a future contract for wheat, he usually holds a value worth 5,000 bushels. Trading the contract would be dealing based on the value of the 5,000 bushels of wheat.
Although futures contracts only require a fairly small investment (usually ten percent of the contract value, known as the margin), investors should still think before taking or buying a futures contract. Beginner traders should first try to establish that they can afford to trade such a contract. Traders should consider if they have enough margins to cover the contract as well as if they have what it takes to trade and deal a sizable move in prices that can go against their position.
It is also important that beginner traders try to establish a system of risk and reward when trading for a particular commodity. There are many factors that may affect the position of the trader in different futures contracts since they can involve a variety of commodities. Traders should have a good idea on how to handle their position in order to make money in futures trading. A good way to do this is to establish a stop loss feature on traded futures. This simply means that the investors establish a certain price range wherein the contracts may stop trading in order to preserve profits from the trade or to minimize the possible losses.
Beginner traders should also consider spreading their trading from a variety of commodities instead of only dealing on one. If one has the capital to afford in trading five futures contracts, it would be wise to have the contracts involve a variety of commodities. This way the risk may be spread over a varied number of commodities, thereby providing a more or less stable position when one of the commodities suffers a decrease in price value. Dealing with only a single commodity in this case can considerably increase the possible losses.
Beginner traders should only try to risk about five percent of their trading capital on futures contracts. The reason for this is because, one can also easily lose considerable capital in futures trading. It is wise for traders to only invest the amount that they are prepared to lose.
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