Commodity futures are agreements to buy or sell a particular commodity at a set price on a future date. To trade commodity futures, you will need to know how to trade futures. You can trade futures contracts on an exchange, and the prices of these contracts are determined by supply and demand.
Traders use commodity futures because they provide a way to hedge against price movements in the underlying commodity. For example, if a farmer is concerned about the price of wheat falling, they can sell a wheat futures contract. If the price of wheat decreases, the farmer will make a profit on their contract. However, if the price of wheat rises, the farmer will make a loss on their contract.
Commodity futures differ from commodity stocks because they do not represent ownership of the underlying commodity. Instead, they are simply an agreement to buy or sell the commodity at a set price on a future date. Therefore, traders can take positions in commodity futures without owning the underlying commodity.
Price discovery
Price discovery is finding out the price of a good or service. The price of a commodity future is determined by supply and demand. Therefore, traders can use commodity futures to determine what the market thinks the price of a particular commodity will be in the future.
Leverage
With leverage, you can use debt to buy an asset. When you buy a commodity future, you are only required to pay a small deposit or margin. You can dominate a large amount of the underlying commodity with a small amount of money, leading to higher profits if the commodity’s price moves in the direction you expect. However, it can also lead to higher losses if the commodity’s price moves against you.
Liquidity
Liquidity measures how straightforward it is to buy or sell an asset. Commodity futures are traded on exchanges, which means there is always someone willing to buy or sell your contract, making it easy to get in and out of positions.
Flexibility
Traders can customise commodity futures contracts to suit their needs. For example, traders can choose the commodity they want to trade, the amount of the commodity they want to trade, and the date they want to trade.
Transparency
The prices of commodity futures are determined by supply and demand. Therefore, traders can see what prices other traders are willing to pay for a particular contract, making it easy to determine the market’s thoughts about a particular commodity.
Diversification
Diversification is the process of spreading your investment across different asset classes. It can help reduce risk because your investment is not reliant on any one market. Commodity futures provide a way to diversify your portfolio by investing in different commodities.
Tax benefits
In some cases, commodity futures can provide tax benefits. For example, in Australia, capital gains from commodities are exempt from taxation. You only have to pay tax on your profits if you sell your commodity future for more than you paid for it.
Access to new markets
Commodity futures can provide access to markets that would otherwise be inaccessible. For example, if you want to invest in commodities from other countries, you can buy commodity futures. It can help you to diversify your portfolio and access new opportunities.
What are the risks of trading commodity futures?
Volatility
Volatility measures the fluctuation of the price of a commodity future. Commodity futures can be volatile; therefore, prices can move sharply in either direction. It can lead to losses if the price moves against you.
Margin calls
A margin call is when your broker asks you to deposit more money into your account to cover losses. If the price of a commodity future moves against you, you may be asked to deposit more money to cover your losses, leading to financial hardship if you are unable to meet the margin call.
Counterparty risk
Counterparty risk is the risk that the other party in a transaction will not honour their obligations. When you trade commodity futures, you enter into a contract with another party. If the other party does not honour their obligations, you may lose money.
