How to Invest in Commodities
There are a number of different ways begin trading in commodities. One of the most common is known as a future position. Essentially, a futures contract is an agreement to buy or sell a specific commodity at a specific time at a certain price. In other words, the investor will “predict” where that commodity will move. The individual will hope that he or she makes a profit from any changes during this time period. A contract will be written and the client will normally close this position before the physical delivery of the commodity in question. Therefore, the investor never actually “owns” the commodity; he or she is only speculating how it will move in relation to the markets. Note that even a negative change is profitable if it is predicted.
Another common investing strategy is to become involved in the stocks of a company which deals with commodities (such as an oil or gold firm). Obviously, the underlying price of the stock will reflect the movements on the open market. Those who are familiar with stocks may prefer this over a futures trade. However, it should be kept in mind that the price of the stock may be influenced by other factors such as company financial statements, a share split or a change of management.
An ETF is also known as an Exchange-Traded Fund. These are excellent for those who wish to trade directly with a commodity without being subject to a futures contract. However, an ETF will normally track the movement of an entire index. This could possibly signify that this change will not be fully displayed in an individual position. Also, not all commodities will offer an ETF position.
Things to Take Into Account
While the commodities market may represent a welcome one-off from a more liquid position, there are several variables that always need to be taken into account. The first consideration will be the predicted movement of a certain commodity over a period of time (such as a rise or fall in gold prices). Other considerations include:
- What are the associated brokerage fees?
- How much can afford to be lost on a particular position?
- What is the time frame involved?
- Are there any trading restrictions?
- What is the reputation of the broker in question?
Understanding these metrics is important before entering into any commodities trade. This sector can be quite rewarding if approached with the appropriate insight and clarity.