Commodities - A Brief Introduction to Trading Commodities
Commodities have a characteristic of their own in that there are a number of different types. Because of this, they are split into different groups and traded on different exchanges.
A commodity is an article or raw material that is bought or sold as opposed to the share or stock trading value of a company, or a currency trading system like the Forex. Some examples of these groups are coffee, sugar cocoa and cotton which are a few of the commodities in the group known as softs. Another group, known as grains includes rice, soya, soya beans, wheat and oats. A meat group comprises pork bellies, cattle, live cattle and lean hogs. There are many more including metals, financials energy and even investment institutions.
Traders talk in terms of spot and futures trading. When spot trading a commodity, the trade takes place immediately or on the spot, hence the term. Alternatively a futures commodity trade is based upon drawing up a contract with respect to an agreed price. This price is a forecast of what value a specified amount of the commodity will reach by an agreed date in the future.
Depending upon the commodity, there are various specifications in terms of how their amount is measured. Gold, for instance, is measured in Troy Ounces, wheat in bushels and crude oil in barrels. Since the value of the commodity is subject to price fluctuations, both parties are, by way of the contract, hedging their risk.
To ensure they get a fair price for their commodity and to know their costs in advance, the seller will secure the future price of their goods by hedging. This is done by drawing up a futures contract to which the buyer will also be similarly tied. There is however, no commitment or obligation to hold the contract until its expiry date and it may be sold at any time prior to then. In reality not even five percent of contracts are held until expiry.
It should be noted that there is no limit to the amount of contracts that can be held for the same commodity and that they can be for either the same, or a different price.
Should either party on each side of the contract no longer wish to hold it, it will be offered onto the market for closing and a speculator or commercial entity will either buy or sell it. Almost ninety five percent of contracts are closed before their expiry date. The amount of commodity trading is always huge and this has the effect of keeping prices fairly steady particularly closer to the date of the end of the contract.
Owing to their liquidity, their leverage of about tenfold and the fact that speculators do not have to physically hold a commodity; it is a highly lucrative investment opportunity. Risk management strategies should, as with all trading, be adhered to.
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