Commodity Market Investing
Commodities are a part of daily life, whether they are food, metal or energy-related. Commodities are a great way for the average investor to diversify their portfolio beyond the standard bonds and stocks, or to profit on market fluctuations. Most people did not invest in commodities years ago, because doing it required a lot of time, skill and money. Today, there are a number of ways to break into the commodities market (futures, funds and options), and most are easy enough for even novice investors.
The most common way to invest in the commodities market is through the buying of futures contracts. Futures are an agreement to sell or buy a quantity of a product at a set price. There are futures available for commodities like gold, oil and natural gas, and foodstuffs like corn and cattle.
Most people that participate in the futures market are institutional-level users of the traded commodities. These people use the market to minimize their losses in the event of a price drop. Other participants are speculators that hope to profit when the price goes up. The speculators typically sell their positions before the contract matures and never actually possess the product. Investing in futures will require you to open a brokerage account, if your existing broker does not deal in futures.
Every commodity contract requires a minimum deposit, which will vary depending on the broker you use. The value of your account will rise and fall commensurate with the contract's value. If the contract's value declines, you will have to deposit additional money in order to hold your position. Due to the high leverage, small market fluctuations mean big profits and losses.
Most futures contracts have associated options. These , options allow you to invest in the contract, but they cap your losses at the option's cost. Options are part of the derivatives market and they do not move in lockstep with the contract. Here are some of the advantages of investing in the commodity market through futures:
The investment is a pure play on the commodity in question.
The leverage involved means big profits
Option accounts allow people to invest in contracts they would not be able to afford otherwise.
The disadvantages:
The commodity futures market can be volatile, and direct investment carries a lot of risk.
Leverage means big losses.
Trades can go bad quickly, meaning that you will lose your deposit and maybe even more before you can close the position.
Many that want to get into the commodity market use stocks, which are less prone to price fluctuations than futures. Investors in stocks need to research before they buy shares, making sure that the company is an acceptable commodity play and investment. There are many stock sectors to choose from, such as oil drillers and refiners, or oil companies.
Stock options require a smaller initial investment than a direct stock purchase, and they are another way to invest in the commodity market. Risk is capped at the option cost, and price fluctuations don't reflect the stock.