Advantages and disadvantages of trading in commodities

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Investments in commodity refer to trading in such assets like grain, oil, gold and silver and other precious metal. There are various methods to invest in commodities like an investor can invest in futures contracts, commodity-based mutual funds, or can buy a physical asset, such as a bar of gold. Investing in commodities is different from other investment it is not like investing in normal stocks and bonds. Trading of commodities is usually carried out as futures contracts on a commodities exchange. Many investors refer quality commodity tips, gold and silver tips for earning a better return on investment.

Examples of commodities include gold, silver, wheat, rice, coffee beans, sugar, salt, etc. There are two types of commodity first Soft commodities that are goods that generally are grown, while hard commodities are extracted from mining.

There are many advantages and disadvantages of the commodities markets. At one side it provides better opportunity to earn a profit while it also considered as high-risk, high-reward investments. If you have too many commodity investments in your portfolio, sometimes it might be dangerous for you.

Advantages of commodity trading:

  1. Higher growth opportunities. A rapidly increasing demand for a commodity can see increases in prices significantly time to time. It provides a lot of opportunities to make quick income through commodity investment.
  2. Diversification – Diversification is when you invest in a variety of industries that give results differently to changes in the market. It will keep your annual profit stable and also avoid big losses. If you’re looking to hedge against your stock and bond investments, investing in commodities can be the right option for you manage risk in the stock market.
  3. Provide security against inflation. Inflation is bad for regular trading. At the time of inflation, it down your stock and bond investment profit while commodities usually positive in the time of inflation. Because when the price of goods and services increase, the value of commodities needed to produce these goods and services will automatically rise. By keeping some commodities in your investment portfolio, you can take advantage of market upswing.
  4. 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.
  5. 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 MCX GOLD contract is currently worth in excess of 35,00,000 INR and could be bought/sold for as little as 100,000 INR. The expense of buying/selling 35,00,000 INR could be 100,000 INR + or -.
  6. 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-minis 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.
  7. 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.
  8. 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:

  1. Highly volatile market: Commodities are most volatile security among other assets. According to one study commodities are almost double as stocks and four times as volatile as bonds. This volatility makes commodities very risky for some traders. This one is a negative point of commodity trading.
  2. Sometimes no income generation: Just like another asset as stock and bonds, Investment in commodities doesn’t generate large income for the investor.
  3. Leverage: 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!
  4. Speed of trading: Speed of trading traditionally commodities is pit traded and in order to trade a speculator would need to contact a broker by telephone to place the order that 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.