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An Introduction to Commodity Trading

Mar 20, 2008
The distinctive characteristic about commodities is that they can be of different types. It is due to this feature that they are traded on different exchanges after being split into different groups. A commodity is something that can be bought or sold unlike shares or the stock trading value of a company or a system of currency trade like the Forex. There are many groups of commodities.

For example:
a. Softs.
Examples of these are sugar, cocoa, cotton, coffee.
b. Grains.
Examples of these are rice, oats, soya beans, wheat etc.
c. Meat.
Examples: pork bellies, lean hogs, cattle and live cattle.
d. Metals.
Examples: Iron, copper, aluminum, etc.

There can be other groups as well, such as energy, financials, even investment institutions.
There are two commonly used terms by traders when talking of commodity trade. These are:
Spot trading: Here, the trade occurs on the spot.
Futures trading: Here, commodity trade is based on the drafting of a contract with an agreed price. This price is the price a specific amount of the commodity will reach at a future date.

There are different terms for measuring different commodities.
For example:
-Gold is measured in Troy Ounces
-Wheat is measured in bushels
-Crude oil is measured in barrels.

Commodity prices undergo price fluctuations and so, both parties are hedging their risks by drafting a contract.

Sellers secure the future prices of their goods by hedging. They do this in order to make sure they get a fair price for them, and to ascertain their costs in advance. To do this, the seller drafts a futures contract with the buyer to which he (the buyer) will be similarly committed. However, there is no obligation for them to continue to hold it up until its expiry date, so it can be sold at any time in the interim period. More than ninety five percent of contracts are terminated before their expiry in this manner. An endless number of contracts can be held for the same commodity for equivalent or different price values.

If neither party wishes to hold onto a contract, it can be offered on the market for closing so that a speculator or a commercial entity can buy or sell it. Almost all contracts are closed this way before they reach their expiry term. Since the amount of commodity trading is always extensive, it has the desired effect of stabilizing prices especially close to the date of expiry of a contract.

Commodities count as extremely lucrative investment opportunities due to their liquidity, high leverage (almost tenfold) and the fact that speculators do not physically have to hold onto them. However, risk management strategies are important for commodity trading as with all trading ventures.
About the Author
Mark Plummer is a UK based independent Offshore Investment advisor.Has been involved in the financial services and financial planning business since leaving full time education.
If you want to learn more on commodity trading then please visit this Investment Fund
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