Most investors know about tradable commodities, but not as many take advantage of them. Commodities are a great addition to any portfolio, as long as you invest prudently. Below, you’ll find everything you need to know about commodity trading.
Commodities are the perfect addition for investors looking to diversify and solidify their portfolio. Here are some of the biggest benefits of commodity trading:
Profits can be huge. For skilled investors, the commodities market offers magnified wins (and also losses). Commodity futures are bought almost entirely on margin, so the variance is much higher.
Diversifies your portfolio. Investing completely in stocks is a dangerous proposition, no matter how safe they are. Commodities safeguard you against crashes and economic disasters.
Protects against inflation. A weak economy means the value of money goes down, which causes inflation. During periods of inflation, the price of commodities tends to go up. This makes commodities an ideal way to protect your portfolio against inflation.
Charges low commissions. Compared to stocks, the commission you pay for each commodity transaction is low. This makes commodities perfect if you make a lot of short-term trades.
Most commodity trading is done through futures contracts. These contracts are agreements that you will pay or sell a specific commodity at an agreed-upon price. This way, you don’t have to make room for physical items, like hundreds of barrels of crude oil or living livestock.
Many different types of commodities can be traded. Here are the four main categories:
The best way to dip your toe into the commodities market is by starting off with a tried-and-true strategy. Here are some of the most common strategies used by commodity traders:
Range trading is a simple concept. All you need to do is identify the support and resistance lines in a commodity’s trade chart. Once you’ve identified these two points, all you need to do is buy when you’re close to the bottom of the range and sell when you’re close to the top.
Breakout trading also relies on the support and resistance points of a commodity’s price. In this strategy, however, you aim to identify when prices are ready to break through these points. Once they do, you should be able to ride a strong push towards a brand-new high or low point.
The Japanese yen (JPY) is the currency of the geographically small, but financially powerful nation of Japan. The currency tends to have a lower interest rate than some comparable currencies, causing it to trade more erratically than the US dollar or the EU euro. Thus, while average trading days see 30-40 pips, volatile days can see as much as 150 pips.
It’s risky to fill a portfolio up with only commodities, but they’re an integral asset for many investors. Portfolios filled with stocks, for example, would greatly benefit from commodities. Stocks are closely tied to the economy, so commodities provide protection against inflation.
Frequent short-term traders would also do well to speculate a bit in commodities. Since commissions are so low, you won’t pay nearly as much for each transaction. The volatility of the market makes this a riskier proposition, however.
Certain industries also trade in commodities as a way to hedge their risk. Airlines, for example, require an incredible amount of fuel in order to operate. If they had to pay the market price for fuel, their costs would fluctuate wildly and their finances would be impossible to predict. They purchase forward contracts that lock in the price of these commodities to stabilize their business.
Finally, commodities are a great option for a low-risk portfolio that needs a bit more upside. The enormous variance of commodities provides the potential for huge gains. In small doses, this gives a solid portfolio some home-run potential.