How Does Commodity Futures Trading Work?

The commodity futures market sets optimal prices. Without the existence of a futures market the liquidity of these commodities would be very low and consequently raw materials and products would be much more expensive, which ultimately affects the value of the finished goods and products. How Does Commodity Futures Trading Work?

What are futures

A futures contract is an agreement whereby the seller undertakes to give the underlying asset to the buyer. The instrument is sold at a pre-agreed price and at specified times. 

It is very difficult to invest successfully on the stock market or buy currency without considering the fact that commodity prices affect the value of stocks and bonds of the companies that use raw materials to produce their goods. Almost any company which issues shares is dependent on the price of raw materials. For example, transportation companies depend on the price of oil, from which gasoline is derived; food manufacturers are directly dependent on the price of sugar, wheat, meat, and soybeans.

Principles of Futures trading

  • On the investor’s account, there must be an amount that covers the collateral. The optimal variant is to make a trade with such an amount, so that it will be possible to trade even if losses are incurred in the futures.
  • When you buy or sell futures, there is a fee. It is charged by the exchange and the brokerage company, through which the transaction takes place. However, the commission is low. It is lower than when trading stocks or bonds.
  • If an investor buys a futures contract in anticipation of an increase in the value of the underlying asset, it is called a “long position. If the price is predicted to fall, it is a “short position”. 

Futures trading on the futures market is risky. It is necessary to consider several important parameters:

  • Volatility. It is a question of price changes. A sharp fall or rise of the asset is called a volatility period. At such moments, it is possible to make a quick profit. But there is also the other side of the coin. If you stand in the wrong position, you can quickly lose all the money.
  • Liquidity. The liquid instruments on the exchange market are good as they can be sold quickly. To find such futures it is necessary to look at the number of submitted applications.
  • Diversification. Trading one’s futures will sooner or later lead to losses. Successfully predicting the future value of the asset for many years is impossible. Professional investors use hedging. That is, they trade futures on different assets. And some of them may be inversely correlated to each other.

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