Why Trading Commodities And Futures Is So Risky

Commodities trading should be restricted to those who’ve made at least $ 1 million in the stock market. That rule would save many lambs from being badly fleeced. Unfortunately, anyone with a few thousand dollars to invest is welcome to risk ruin in commodities markets.

Commodities, also known as futures, includes a wide variety of products from gold and silver to live cattle, wheat and currencies. Generally speaking, the major agricultural commodities markets are in Chicago. The main currencies and financial markets are in New York.

All participants in commodities markets are either hedgers or speculators. Agricultural hedgers include large farm operators and food makers, hedging against the possibility of big price changes in commodities such as wheat, corn, live cattle etc. Financial hedgers include large investors and portfolio managers seeking to protect the value of their portfolios against major currency and/or market changes.

Speculators seek to profit by accurately predicting the future prices of commodities. At first glance, commodities speculation may seem attractive. Margin requirements are typically low in comparison with the stock market. For instance, for a $ 5,000 margin deposit, you may be able to buy or sell a commodities contract worth $ 50,000 or more. Moreover, no interest is charged on the balance of the contact’s value. Thus, if you are correct in your price predictions, profits can be huge. Alas, so can losses, and losses are far more likely.

You can lose $ 100,000 (or many times that amount) in the blink of an eye in commodities. In many commodities positions, potential losses are unlimited! Since your margin deposit covers only a small part of the contract’s value, your losses could far exceed your margin deposit, even with a fairly minor price move against your position.

Here are two (of many) additional factors which make commodities markets so risky:

1. Commodities markets are a true zero sum game. In the stock market, it is possible to profit by buying, selling or simply holding a stock for a long time. In commodities markets, every dollar made by one trader is taken from another. If the seller wins, the buyer loses. If the buyer wins, the seller loses. When you account for brokers’ fees, commodities is even less than a zero sum game. In other words, you’ve got to outsmart your competitors head to head to profit in commodities.

2. The second additional factor, making commodities so risky, is that your direct, head to head competitors include some of the world’s biggest and smartest investors. An average person wouldn’t expect to win a boxing match with an international heavy weight champion. Why should they expect to win competing against the likes of George Soros, Warren Buffet and other heavyweight investment champions? You may not see you financial competitors, but that doesn’t make them any less real.

Most likely, you should avoid commodities markets like the plague.