Checklist Description
This checklist outlines the why and how of commodity or futures trading.
Definition
In contrast to other kinds of investment, such as stocks or bonds, when you trade in commodities or futures you do not in fact buy or own anything. You are speculating on the future direction of the price of the commodity. The terms “commodities” and “futures” are often used to describe commodity trading or futures trading. Commodities are the actual physical goods, such as corn, soybeans, gold, or crude oil. Futures are contracts for those commodities, which are traded at a futures exchange such as the Chicago Board of Trade.
Futures are standardized contracts among buyers and sellers of commodities, specifying the amount of a commodity, grade/quality, and delivery location. Each futures exchange has producers and consumers who want to hedge their risks of future price changes. In between them are the traders, who do not actually buy and sell the physical commodities but are there to help maintain an organized market and provide liquidity. Futures markets are generally very actively traded, so typically there is a large daily price range and trading volume.
Futures contracts have now expanded beyond just physical commodities, and there are futures contracts on financial markets such as the S&P500, treasury notes, currencies, etc.
Futures markets can be traded in both up and down. If a trader expects the market to move upwards, he will make a long trade by buying a contract and leave the trade by selling a contract. Conversely, if a trader expects the market to move downwards, he will make a short trade by selling a contract and leave the trade by buying a contract. By being able to trade in both directions, traders can make a profit or loss regardless of which direction the market is moving. In order to make decisions about when to trade commodity futures, traders tend to use price-activity charts that show futures movements and which are easily understood when tackling historical and current price movements.
Advantages
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Futures markets are available with a wide variety of underlying instruments, which in turn offer a wide range of price movements and liquidity. Some are available for day-trading 24 hours per day.
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Futures markets can be day-traded without any restrictions, which makes them preferable to stock markets that have day-trading restrictions.
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Futures markets are offered with trades in currencies such as the euro to US dollar exchange rate, stock indexes such as the Dow Jones and DAX, and commodities such as gold, silver, and oil.
Disadvantages
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Unforeseen events such as floods, droughts, government currency interventions, and crop reports can cause sudden and unpredictable losses.
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Risk and reward go hand in hand. It is ridiculous to expect to be able to earn above-average profits without above-average risks.
Action Checklist
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Learn about and specialize in a particular commodity before you begin trading. Every commodity has different trading guidelines and a profile that includes the basics of contract specifications, market reports, and charts.
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Begin trading with small amounts until you learn the ropes; trades on some exchanges are available for as little as $100.
Dos and Don’ts
Do
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Do your homework and start by trading in small amounts until you are thoroughly familiar with your chosen commodity.
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Use price-activity charts before making decisions about when to trade in futures.
Don’t
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Don’t forget that, although the risks can be managed, they can never be eliminated. Keep in mind that the high returns are available only because the trader is being paid to take risk away from others.
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Don’t forget that losses are part of the process and that the best traders lose money, but over time they make even more.
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