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.

---

Day Trading Course or Day Trading Technique Seminar: Learn Day Trading Education

Profitable day traders recognize that momentum trading is among the... Read More

The Nature of the Trading Business

Consider the following: As a trader you are in a... Read More

The Major Players in the Foreign Currency Exchange Market - FOREX

Since the US dollar is the centerpiece of the market,... Read More

The Margin Advantages of Trading FOREX.

There is one aspect that is considered as one of... Read More

Stocks Trading - Advantages and Disadvantages

What is Stocks Trading?Companies throughout the world issue new stock... Read More

What I Learnt Losing £60,000 My First Year as a Full-time Trader

During my first year as a local (independent trader) on... Read More

FOREX - Where Fortunes Are Made Everyday

The Foreign Exchange Market ? better known as FOREX -... Read More

A Fools Game

I received an email this week with a question (below)... Read More

Experience

Throughout our course on futures trading, we have tried to... Read More

Is The U.S. Dollar About To Reverse Course?

For the first time in several years the U.S. dollar... Read More

Be a Smarter FOREX Currency Trader: Three Basic Principles

Below I will describe three basic principles that may come... Read More

Discovering Turnaround Candidates

There are many types of investment methodology out there. All... Read More

Intrenet Marketing VS Forex Currency Trading

Have you noticed that when someone's trying to sell you... Read More

What are Your Options Regarding Forex Options Brokers?

Forex option brokers can generally be divided into two separate... Read More

Forex Profits

The Forex Market-What, When and Why?Forex, FX and the Forex... Read More

Forex Signal, Forex Signals Advice

There are lot's of Forex signals providers out there. New... Read More

Mechanical or Discretionary Trading - Which is Best?

Discretionary TradingPure discretionary trading will rely solely on the traders... Read More

Trade Exit - How To Cut Losses And Let Profits Run

Cut your losses short and let your profits run. This... Read More

Forex Broker Involvement Optional

To trade on the forex market, the largest financial market... Read More

6 Critical Factors For Successful Trading

Success in any profession can be broken down into a... Read More

Getting a Forex Trading Education

Many Americans are interested in getting involved in forex trading.... Read More

Option Arbitrage in the Forex Market

What is arbitrage? Arbitrage is the simultaneous buying and selling... Read More

Online Forex Trading

Foreign exchange currency trading is also known as Forex trading,... Read More

Online Stock Trading: Freedom of Trade

I remember the first time I started to trade online.... Read More

Commodity Trading - Advantages and Disadvantages

What Is Commodity Trading?Commodity futures markets allow commercial producers and... Read More

Writing A Trading Plan

All professional traders have a trading plan. Trading futures is... Read More

Creativity in Trading

"Is it important to be creative in your trading?"I'm not... Read More

The Secret of Reduced Margin Spreads

One of the best kept secrets in trading is that... Read More

Factors Influencing a Currency Pair Exchange Rate

IntroductionThe exchange rate refers to the value of the US... Read More

Forex Trading Online - 7 Reasons Why You Should!

Forex trading online is a fast way to use your... Read More

Example of a Profitable Transaction in FOREX

To make a profit, in the FOREX, a trader can... Read More

ISO 4217 in Forex Trading

ISO 4217 is an international standard describing three letter codes... Read More

Crisis of Confidence in the EU

The European Union (EU) constitution was dealt a double blow,... Read More