How Commodities Trading Works

Commodities are resources that our civilization needs to operate. The commodities market exists to maintain a constant supply of these materials to industry. It performs this role by ensuring that suppliers receive the best price possible for these products.

Commodities trading are based upon options, an option is a contract to buy a set amount of a certain product such as wheat. Options or futures can be bought and sold much like stocks. This trading was created to ensure farmers with a steady market for their products and buyers with a steady supply. When people trade commodities they are actually purchasing contracts or options.

The trader hopes that the value of the commodity and the value of the option will increase. That way he or she will be able to sell it and realize a profit. That makes options trading a kind of speculation rather than investment. A speculator such as a commodities trader hopes to make a profit on a transaction.

Commodities Exchanges

There are two principal kinds of commodities contracts traded on the major exchanges like the Chicago Mercantile Exchange spot options and derivatives. A spot option is a contract that enables somebody to take ownership of a set amount of a commodity such as a train car full of grain at a certain date. A derivative is a security or equity based upon the potential value of an amount of a commodity.

Commodities traders purchase both of these often using margins or funds borrowed against the potential future profit form their sale. A margin account is actually a credit line that a person can use to finance trading. The trading was originally done in pits at organized exchanges such as the Chicago Merc. Today, it is mostly done electronically through a computerized network.

The internet allows anybody with a brokerage account and an internet connection to engage in commodities trading. This trading is actually speculation buying and selling of commodities in a systematic manner in an attempt to realize profits from rise and fall of prices.

The Price of Commodities

The whole basis of the commodities system is the price. When a speculator buys a commodity she is betting that the price will go up. When she engages in market timing she is trying to figure out when she can sell for the best price.

Commodities are not good investment for the average person because they are in constant flux. A person has to monitor the market constantly and sell at the right time to earn a profit. Therefore this kind of trading is best for a person that wants to devote a great deal of time to it. Persons who want to take a more hands off approach to investing should look into more passive instruments such as stocks.

What is a Commodity?

In today’s world almost anything can be a commodity. The original commodities exchanges traded agricultural goods like rice and wheat. In the 19th century minerals such as gold, silver and platinum were added, later still energy products such as oil and raw materials used in industry were added. In the 20th Century derivatives were created to expand the range of trading. Many modern derivatives are actually based upon stocks and other equities. Exchange-traded funds actually began on commodities exchanges.

The best way for average people to invest in commodities is through exchange-traded funds or mutual funds that invest in commodities. These vehicles should be a small part of your portfolio because the market they trade in is extremely volatile.

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