Remember the old TV show, WKRP in Cincinnati, in which the dorky Les Nessman would always give the pork bellies report?
Or how about the 1980’s movie, Trading Places, in which Eddie Murphy and Dan Akroyd corner the orange juice market? These are both examples of commodity trading in the popular media.
Commodity trading is one of the fastest growing sectors of the financial markets, and for good reason – in 2006, commodity prices have gone through the roof. If you haven’t heard anything about the prices of pork bellies or orange juice skyrocketing, that’s because there is much more to commodity trading than just these two items.
Corn, oats, soybeans, wheat, soy meal, bean oil, cattle, coffee, sugar, cotton, steel, copper, silver, gold, platinum, natural gas, crude oil, and gasoline are just a few of the dozens of commodity trading options. Metals – steel and gold, in particular – and petroleum-related products, have seen major price movements in the past year.
Commodity Trading – Buy Low, Sell High; Or Sell High, Buy Low
If you remember back to Trading Places, the classic commodity trading comedy, Eddie Murphy and Dan Akryod entered the trading pit and immediately started selling orange juice contracts.
They didn’t own any orange juice, but they were able to sell it anyway. This is how commodity trading works – you either hope to buy low, sell high; or sell high (first), and then buy low.
Commodity Trading Hedgers
This aspect of commodity trading can best be understood by taking a look at the market participants. On one hand, you have the hedger. Hedgers want to guarantee commodity prices in order to lock in profits or avoid excessive losses.
For example, imagine a jewelry maker who needs 1000 ounces of gold to make a collection of necklaces. He needs the gold in six months, but the way gold prices have been going up, he’s worried that he won’t be able to afford it.
To hedge in the current price of $500 per ounce, the jewelry maker could buy ten 100 ounce futures contracts on a commodity trading exchange. Then six months later, if the price has gone to $700, the value of his contracts will have gone up by $20,000 each.
He can sell the contracts for a profit and use the proceeds to buy the actual gold, which will result in a net price of $500 per ounce.
If, in the above example, the value of gold had actually fallen to $400 per ounce, the jewelry maker would have lost money. He’d be locked in to paying $500 per ounce for gold when the actual market value was only $400.
Still, if the jewelry maker’s primary concern was to not end up paying $700 per ounce, this will have been a valuable commodity trading experience. In this way, hedgers use commodities contracts like insurance.
Commodity Trading Speculators
On the other side of commodity trading is the speculator. This is someone who has no business interest in wheat, crude oil, or copper, but essentially gambles on the price of each commodity going up or down.
Commodity trading is very popular with speculators because it requires very little margin. This means that commodity trading speculators can control thousands of dollars worth of commodities for just a few hundred bucks.
The downside of leverage in commodity trading is that it can lead to very big losses that you might not be prepared for.
For this reason, your credit history will be more important when applying for a commodity trading account than an account to trade in almost any other financial market.
William Smith lives in Florida with his wife and three cats. William writes frequently on many subjects that may be of interest to all. Discover all the joys and secrets of backgammon at Backgammon Board Game