Basic Principles Applied in Commodity Trading

There are some fundamental principles that individuals need to know and to understand if they would like to enter the commodities market. Some of the concepts may actually be applied in other markets as well. Physical goods like metals, grain and food than can be exchanged are considered as commodities. Practically almost all of the everyday things that people make use of or consume come from commodities such as gasoline, natural gas, cocoa, sugar, coffee and many more. These raw materials or products may range from soft commodities to energy sources and to abstract commodities as well.

Some traders transact in a spot market where exchanges are immediate. A trader who represents a large company for example may purchase large volume of gold or oil on the spot. Regular people who make small purchases of the things that they need are actually involved in spot trading.

There are also traders who trade in the futures market. The buyer and the seller would agree on the terms of their transaction that will be carried out at a future date. They will also have to agree on the price of the commodity being transacted. However, it is important to understand that the parties do not actually engage in the exchange of the physical product right away but they are dealing with a contract.

This form of trading protects the parties from possible fluctuations of the price in the future. One of them will gain while the other losses in case the price would increase or decrease. Farmers for example may protect their gains by ensuring that their harvest will be bought at a specified price in the future.

However, trading in futures may pose lots of risks to traders. Some of them would limit the danger of losing much by trading options as well. Traders only risk the premium that they have paid including the commissions and other fees. They are only given the right to buy or to sell and they can exercise their option if they decide to unlike futures contracts where the seller will have to deliver the actual volume and quality of goods that have been agreed upon.

Although traders have the advantage of using leverage when trading futures contract, they have to learn how to use it wisely. Commodities trading can also be very risky and some traders may lose all if they are not careful. The leverage that is at the disposal of traders is the main reason that makes the futures contract more volatile rather than the value of the underlying asset or security.

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