The Myths of Investing in Commodities Futures

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Many investors are reluctant to trade commodities due to a variety of myths or misconceptions held by the general public and sometimes even within the investment community. These long-standing myths date back many decades and were likely created by frustrated, losing commodity traders or by those who view the commodities market as too difficult to understand.

You may hear comments like "commodities are too volatile," or "you'll have a truckload of soybeans dumped on your front lawn." Unsuccessful traders looking for an excuse might claim that "nobody can make money from trading commodities."

In reality, people can and do make money trading commodities, and there are many successful traders—even private, amateur traders—who clearly understand the commodities market.

Here is a look at some of the myths and misconceptions about investing in commodities.

Key Takeaways

  • A futures contract only requires you to put up 3-15%, but commodities are no more volatile than stocks if you remove the leverage factor.
  • Commercial investors handle physical deliveries, but individual investors close their futures contracts before the first notice day to avoid them.
  • You can often open a commodities trading account with as little as $2,500 or $5,000, but this always should be risk capital you can afford to lose.
  • Successful commodities traders trade fewer contracts than the margin requirements allow and often trade over decades to gain experience.

"There Is Too Much Leverage in Commodities"

By far, leverage is the biggest problem when investing in commodities. Unlike stocks, where 50 percent margin is required, a commodity futures contract only requires you to put up 3 to 15 percent of the total value. And, of course, many new commodity traders don’t know how to handle this newfound gift of incredible leverage. In reality, commodities as an asset class are no more volatile than stocks if you remove the leverage factor.

The mistake made by many commodity investors is that they invest a $25,000 account as if were $250,000. For example, they might buy ten futures contracts that have a margin of $2,500 each and control $250,000 worth of commodities. If the commodities move up a little in value, the trader makes $25,000, doubling the investment. But if the commodities move down a little in value, the investment can be wiped out.

To be successful in commodities, you should plan to trade far fewer contracts than the margin requirements allow. In the above example, you should trade only one or two futures contracts at any given time. Remove the extreme leverage factor that gets so many new commodity traders in trouble.

"You Must Take Delivery"

Many people imagine that they must be prepared to accept actual delivery of the physical commodities. In fact, this is something you really don’t need to worry about as an individual investor. 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.

"I Don't Have Enough Money"

A lot of people avoid commodities because they think it requires a lot of money. But many commodity brokers allow you to open an account with just $5,000, and some even start at $2,500. Granted, this money should be risk capital you can afford to lose, as commodities can be a risky investment. Where problems arise with accounts of this size is when investors take on too much risk for their account size. New investors sometimes 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 than if you try to hit a home run.

"Nobody Makes Money"

Yes, some people do lose when trading commodities. However, the losers are usually ill-prepared investors who jump into the commodity markets and lose their money within six months, never to return again. Others get addicted to the markets, trying, again and again, to make a killing using the same strategies, even though they 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 do 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? The gains normally go to the professional commodity traders and money managers that consistently make money year after year. The amateur commodity traders who make money tend to be those who trade for a long time—over 30 years or more. Over the long term, such a trader has may take money from hundreds of less experienced commodity investors.

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, most of it taken from perhaps 40 losing traders who threw $5,000 into the markets. Successful traders have usually paid their dues by learning how to trade commodities properly. They follow a strict trading discipline that most losing traders never adopt.

You can make money from trading commodities whether you are a novice or very experienced investor. It is not 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. The common myths and misconceptions about commodities futures trading don't offer a true picture.