How to Trade Commodities

Commodities, are an important part of everyday life, and the term ‘commodities’ relates to a number of sectors.

They are:
1. Stock Index Futures
2. Bonds
3. Currencies
4. Energy
5. Metals
    a. Precious
    b. Industrial
6. Agricultural
    a. Grains
    b. Softs
    c. Meats


Commodities are traded on commodity exchanges around the world and are the second largest markets, by volume, traded.

Commodity traders are mostly speculators who seek to profit from a forecast of price direction that has been derived from either technical or fundamental analysis. Commodity investment also provides a way for investors to diversify beyond ‘plain vanilla’ stocks and bonds.

Commodity markets are easily accessible to every trader and investor from straight up futures contracts, options, inter-commodity and inter-market spreads to Commodity Exchange Traded Funds (ETF’s) and Commodity Contracts for Difference (CFD’s).

At Jennings Futures Trader we seek opportunities across all available markets and financial products.

Futures Market
The most common way to invest in commodities is through a futures contract, which is an agreement to buy or sell in the future a specific quantity of a commodity at a specific price. Futures are available on all commodity sectors and in all ‘markets within those sectors.

Within the futures markets there are hedgers and speculators, hedgers use the commodity markets to take a position that will reduce the risk of financial loss due to a change in price, speculators on the other hand hope to profit from changes in the price of the futures contract. Speculators typically close out their positions before the contract is due and never take delivery of the physical commodity.

To take a position using a futures contract you will be required to place margin through your broking service to cover the initial deposit. The margin allows you to hold a position on leverage which will give you the right to benefit if the price action goes the way you anticipate or to lose money if you are wrong. Be careful with leverage, small movements against your position are magnified by leverage and you need to make sure your account is sufficiently capitalised to hold your position.

Advantages:
• It's a pure play on the underlying commodity.
• Leverage allows for big profits if you are on the right side of the trade.
• Minimum-deposit accounts control full-size contracts you would normally not be able to afford.
• You can go long or short easily.

Disadvantages:
• The futures markets can be very volatile and direct investment in these markets can be very risky, especially for inexperienced investors.
• Leverage magnifies both gains and losses.
• A trade can go against you quickly and you could lose your initial deposit and more before you are able to close your position. We suggest traders always set risk limits before taking a trade and to use stop loss orders to automatically exit a trade at a predetermined level.

Stocks
Many investors looking for a commodity plays use stocks, which are less prone to volatile price swings than the futures market. Stock investors need to do some research to help ensure that a particular company is a good investment as well as a good commodity play. There are many stocks and sectors to choose from. Among oil companies, investors can select from drillers, refiners, tanker companies or diversified oil companies. Stocks are easy to buy, hold, trade and track, and it is possible to play a particular sector.

Stock options, which require a smaller investment than buying stocks directly, are another way to invest in commodities. While risk is limited to the premium paid for the option, the price movement will not usually directly mirror the underlying stock.

Advantages:
• Investors usually already have a brokerage account, so trading is easier.
• Public information on a company's financial situation is readily available.
• The stocks are often highly liquid.
Disadvantages:
• A stock is not a pure play on commodity prices.
• Its price may be influenced by company-specific factors as well as market conditions.

Exchange-Traded Funds
Exchange-traded funds (ETFs) trade like stocks and allow investors to participate in commodity price fluctuations without investing directly in futures contracts.

Commodity ETFs usually track the price of a particular commodity or group of commodities that comprise an index using futures contracts.

Advantages:
• They trade and behave like stocks.
• They provide an easy way to participate in the price fluctuation of a commodity or basket of commodities.
Disadvantages:
• A big move in the commodity may not be reflected point-for-point by the underlying ETF.
• Not all commodities have an ETF associated with them.

Contracts for Difference (CFD’s)
Contracts for Difference are financial products offered, on margin, by market makers and allow the trader or investor to control the amount of leverage used in a trade compared to the standard futures contract. CFD’s can be traded over not only the futures contracts but are also available over Exchange Traded Funds and stocks.

Because the leverage can be controlled by the individual to suit his/her particular needs the margin required to cover the leverage of a CFD reflects the lesser exposure. Trading CFD’s over commodities or commodity ETF’s may suit a smaller trading account.

Conclusion
There are a number of different types of commodity investments for novice and experienced traders to consider. Although commodity futures contracts provide the most direct way to participate in price movements, other types of investments with varying risk and investment profiles also provide exposure to the commodities markets. It is important to use the tool that works best for you. Before opening an account check that the service you are using offers the financial product that you require.