July 8, 2008, 6:00 am

How to trade commodities?

by: The Financial Blogger    Category: Investment, Market and Risk,Trading
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In my last post, I discussed how commodities have became more and more traded by both institutional and individual investors. Turn the time back 10 years, and trading commodities was very tough to actually do. It was pretty much only done through futures. Now of course, it’s still possible to trade commodities doing futures and it’s still the most important way to trade commodities. For sure, it has been becoming easier to set up such accounts though, especially through discount brokers such as Interactive Brokers. Doing so, you have a lot of flexibility as you can easily select the specific commodities, trade different types of crude oil, etc.


You will also have a very large array of possibilities of options if you would like to do so.

The problem with trading futures is that it’s not so straightforward. If you do not know how futures work, here is a quick breakdown. You will buy or sell a commodity, let’s say Crude Oil. When buying or selling, you are not sending any money for the trade. What? Yes, you read correctly. Instead, you will only be sending money when you lose money (if crude oil goes down) or you will get credit if the crude oil price goes down. This process is done daily. Straightforward right? Sure, but the problem is that your broker/exchange will not know how much money you have and thus how much of a loss you can sustain. For that reason, they will require that you post a margin, usually an amount of money left in your account in case your position loses money and you’re not able to pay for your loss. Because of that, it’s not easy to trade for beginner investors.



Probably the easiest way to trade commodities is to trade ETF’s that are created to replicate certain commodities. These are bought the same way a stock is bought. The main advantage is that they are very easy to buy, trade, do not require a margin. The drawback for now is that only a few commodities (Gold, Oil, etc) are available. You can also play the Agriculture sector, but playing corn for example is more difficult….


Single stocks

And finally, you can buy specific stocks to gain exposure to specific commodities. For example, you can buy Suncor (SU.TO) if you wish to gain exposure to oil prices as the company makes a lot more money selling its oil with high prices than low prices.

That’s it for now, we’ll go into specific strategies in the coming weeks..! Stay posted!



image source : mmwinvestments.com

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