The Myths of Investing in Commodities
Many investors are reluctant to trade commodities due to a variety of myths or misconceptions by the general public and even the investment community. These myths probably date back many decades and were likely created by frustrated, losing commodity traders or by those who view commodities as too difficult of an investment to understand.
You may hear things like commodities are too volatile or you will have a truckload of soybeans dumped on your front lawn if you trade commodities. Or, a quick response by many unsuccessful traders is that nobody can make money from trading commodities. Well, obviously people do make money trading commodities. Here is a look at the myths and misconceptions about investing in commodities.
Too Much Leverage
By far, leverage is the biggest problem when investing in commodities. Normally, you only have to put up about 3 to 15 percent of the total value of a futures contract in futures margin. That is far less than the 50 percent that is required for stocks. And, of course, many new commodity traders don’t know how to handle their newfound gift of incredible leverage. In reality, commodities are no more volatile than stocks as an asset class if you remove the leverage factor.
The problem with many commodity investors is that they will invest a $25,000 account as if were $250,000. For example, they might buy 10 futures contracts that have a margin of $2,500 each and control $250,000 worth of commodities. Therefore, if the commodities move up a little in value, they made $25,000, doubling their investment. However, if the commodities move down a little in value, their investment is wiped out.
To be successful, you should trade far fewer contracts than what the margin requirements allow. In the above example, you should only be trading 1 or 2 futures contracts at a time. Remove the extreme leverage factor that gets so many new commodity traders in trouble.
Taking Delivery of Commodities
This is something you really don’t need to worry about. Only the commercial players are involved in taking and making delivery of commodities. As long as you close your futures contract before the first notice day, which usually occurs a few weeks before the contract expires, you should have absolutely no worries about this. If for some reason you forget about the first notice day, your broker will certainly catch it and contact you.
You Don’t Have Enough Money to Trade Commodities
Many commodity brokers will allow you to open an account with $5,000, while some even start at $2,500. This money should be risk capital as commodities can be a risky investment. The problem with accounts of this size is that investors take on too much risk for their account size. They tend to roll the dice and bet it all on one trade. Don’t fall into that trap. If you shoot for a respectable return of 25 percent a year, you will do much better in the long run as opposed to trying to hit a home run.
Nobody Makes Money from Trading Commodities
The fact is that many people do lose when trading commodities. However, the losers are usually ill-prepared investors who jump into the commodity markets and lose within six months, never to return again. Others get addicted to the markets while trying again and again to make a killing with the same strategies and just keep losing.
The good news is that commodity investing is a zero-sum game, which means for every dollar lost, someone gains a dollar. Actually, you have to factor in transaction costs, so each person loses a little more than a dollar and the other party gains a little less than a dollar.
So, who makes all the money? It is normally the professional commodity traders and money managers that consistently make money year after year. Also, amateur commodity traders who make money tend to trade for a long time – maybe 30 years. In that time, this trader has probably taken money from hundreds of commodity investors along the way.
Successful amateur traders and professional traders usually trade larger amounts of money. A professional trader managing $1 million may make profits of $200,000 for the year. In reality, he took money from the equivalent of 40 losing traders who threw $5,000 into the markets. Successful traders have usually paid their dues to learn how to trade commodities properly and they follow a strict trading discipline, which most losing traders never adopt.
You can make money from trading commodities whether you are a novice or very experienced investor. I will not tell you it is easy, but if you do your research and use a good trading strategy with sound money management skills you stand a much better chance of success. So, don’t run from investing in commodities because you heard one of these myths that don’t give you a true picture of investing in commodities.