The futures market is a market where trades are conducted at the current moment...for commodities delivered in the future. For this reason, the commodities futures and options market is perhaps the most volatile of all the markets.
Leverage and options in futures further aggravate the volatility of results. "Leverage" is using borrowed money to trade. "Options" means exercising your right at any time before the period expires. Ultimately, commodities are traded by those who know what to look for and are skilled in calling and putting; in other words, buying and selling at specific prices.
A greater opportunity for profits always comes with a higher potential for loss (risk). There are some attributes that those who have the most success in commodities trading have in common. For those looking to get involved, be sure to understand the trademarks of those who succeed.
Learn more about the eight attributes of successful commodities traders.
- For those looking to get involved in commodities markets, it is helpful to understand the trademarks of those who succeed.
- Some of these include being willing to learn futures and options, knowing the margin requirements, and having insights on frequencies.
- Others include being aware of commodity attributes. trading platforms, and market support and resistance.
- Also, be sure to understand fundamental and technical analysis; discipline is also crucial.
1. Be Willing to Learn Futures and Options
This is perhaps the most important tip for those who are looking into the futures and options markets: Spend lots of time learning the ins and outs of futures and the exchanges that offer these financial products.
There are many different commodities and products that trade on the two major commodity exchanges in the U.S. These two exchanges are the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE). Each of these offers plenty of material for those who wish to learn more.
2. Know the Margin Requirements
The margin is a good faith deposit required by exchanges on the products they offer for trading. This is required by many commodities. And others require a maintenance margin. These are payments if the value falls below a certain percentage.
For instance, let's say a gold contract for 100 troy has a margin of $4,950. Its maintenance margin is $4,500. In that case, an investor would purchase the contract for $4,950 (the margin); at the same time, they would maintain a value of $4,500 in the account (the maintenance margin).
What if the value falls below $4,500? The investor must place more cash into the account or sell off shares to make up for the difference. This is called a margin call.
3. Have Insights on Commodity Frequencies
Some commodities trade all through the year. Others trade for specific months set by the exchange. Each contract has a different minimum tick value. This represents the financial results of a minimum unit price change.
Many commodity futures have different specifications when it comes to making or taking physical delivery of the underlying commodity. Others offer only a financial settlement for long and short positions when the futures contract expires.
4. Be Aware of Commodity Attributes
Each commodity has a set of idiosyncratic attributes. This is why it is important to understand exactly what a trader or investor is buying or selling. The exchanges offer information on price, volume, and open interest in each of the contracts they offer. It is important to understand this data and use it when analyzing these markets.
5. Know How to Use Trading Platforms
Commodity traders most often select and use a trading platform that is comfortable for them. It also must offer the services they need.
6. Understand Market Support and Resistance
Commodity prices tend to rise and fall with demand and supply. This is true of all volatile investments. If demand falls, supply increases and prices go down. Once the lower prices begin to attract buyers, the price will fall until it finds a bottom and then begin to rise.
The "bottom" is when the price reaches the lowest level the market can support.
Prices will continue to rise (along with production) because demand has increased. This continues until a level is reached where consumer demand begins to decline due to high pricing. This is the point in which the market resists any higher prices, demand is lowered (market resistance), and prices begin to fall.
This cycle continues with supply, demand, and prices all fluctuating with respect to each other. Market resistance is a force that keeps prices from rising any further; that's because buyers stop purchasing at a certain point. Market support is a force that pushes prices back up. That's when there is enough demand to keep prices from falling lower.
This knowledge is used in both fundamental and technical analysis. Fundamental analysis is an attempt to understand the cyclical nature of a commodity market through the use of supply and demand data.
7. Understand Types of Analysis
There are two main types of analysis that can help lead to success when trading or investing in commodities: fundamental analysis and technical analysis.
What Is Fundamental Analysis?
Traders use fundamental analysis of commodities to find out the feasibility of buying or selling. Understanding futures, options, supply and demand, and their influence on these raw material markets is important.
Fundamental analysts tend to research total supply vs. total demand in different commodity markets at different points in time. Technical analysts spend more time looking at historical data on charts and graphs.
What Is Technical Analysis?
Technical market analysts study the behavior of prices in commodity markets. This is done by using past price trends to predict the future trend. They use charts with graphics to assist them in tracking price movements over time.
Some look at very short-term price data. Sometimes this is as short as one trading day. Others look at longer-term data, such as a year, to understand price behavior. Historical commodity closing behaviors are of most interest to the analysts.
Technical analysts follow the theories of supply, demand, resistance, and support. Using these, they look for and try to predict the points where the market resistance and support levels are going to present themselves. These points are often the best times to buy and sell. That's because they reflect either the lowest or highest prices.
Technical analysis is important for understanding the current path of least resistance for prices and predicting the future.
It's a good idea to use a combination of fundamental and technical analysis. When used with a disciplined approach to markets, this can create an optimal approach.
8. Know Discipline Is Crucial
One of the most important attributes is discipline. Discipline is the ability to make a plan; then, you must stick to it during the ups and downs of the market.
Discipline is also about understanding your own financial limits. You should never compromise your personal assets. Good traders know when they can and cannot support a purchase or possible loss.
Successful traders never put all of their eggs in one basket. Diversifying your portfolio is one of the best ways to avoid this. Having a diverse portfolio means having investments in different markets and commodities. This is far better than having it all in just one.
Many traders have a habit of adjusting their risk to reward by placing stops on long and short positions. A stop is an order to quit buying or selling at a price named by the investor. This is to attempt to buy and sell at the "right" price, to ensure the most profit.
What Are Some Commodity Products Outside of Futures Exchanges?
In the last few decades, exchange-traded funds (ETF) and exchange-traded notes (ETN) became popular. ETFs are equity equivalents of physical products; these replicate the price performance of products traded on the exchanges. This allows traders to trade on commodities without holding the physical asset.
ETNs are more similar to bonds. The note is purchased for an amount less than the face value. When it matures, the issuer pays the face value minus fees.
An understanding of futures exchanges is still necessary when trading or investing in these market vehicles. Fundamental and technical analysis, along with discipline, still hold true when it comes to the ETF and ETN markets in commodities.