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Primer on Commodity Trading

One of the attractions of trading commodities is the potential for gaining large profits in a considerably short amount of time. Nevertheless, commodity trading is considered by most as being extremely risky since most investors tend to lose money. However, by performing your due diligence and determining whether the commodity that you’re interested in is either under- or overvalued, say if you want to go long or short, respectively, you may be able to minimize the risk involved in commodity trading. It may also help to have an experienced commodity trader by your side to guide you.

When you’re trading commodity futures, you’re not truly purchasing nor owning anything, unlike other types of investments, such as stocks or bonds. You’re simply speculating on where the price of a given commodity will be headed. If, after doing your research, you believe that the price of coffee is going to rise, you would purchase future contracts, or go long. On the other hand, if you were under the impression that the price of sugar was going to drop, then you would sell future contracts, or go short.

As was mentioned earlier, one can also purchase futures in currency or market indices, in addition to buying or selling futures on commodities like cattle and hogs. One advantage of trading futures on market indices is that you don’t need to invest a lot of money, as opposed to having to invest a considerable chunk of capital if one were to purchase individual stocks. Let’s illustrate with the following, a $10,000 futures contract on the Nasdaq is equivalent to about $200,000 dollars in stock. Let’s assume you expect the market to rise shortly, you could potentially buy many of the stocks that form part of the Nasdaq stock index (the herd mentality) or you could purchase a Nasdaq futures contract. Suppose you invested $200,000 in stocks in the Nasdaq, and if the index had risen, you would have made a profit of say, $25,000. However, if you instead purchased a $10,000 futures contract simultaneously, rather than investing $200,000, you would have made the same $25,000, by investing with a lot less capital in the first place.