2015-02-01 16:41:00 & Posted by. Mr Mike Mawa

Commodities. whether they are related to food, energy or metals, are an important part of everyday life. Similarly, commodities can be an important way for investors to diversify beyond traditional stocks and bonds, or to profit from a conviction about price movements.

It used to be that most people did not invest in commodities because doing so required significant amounts of time, money and expertise. Today, there are a number of different routes to the commodity markets, and some of these routes make it easy for even the average investor to participate. This article should help you determine which tools will suit you best for investing in commodities.

Futures Market

A popular way to invest in commodities is through a futures contract, which is an agreement to buy or sell, in the future, a specific quantity of a commodity at a specific price. Futures are available on commodities such as crude oil, gold and natural gas, as well as agricultural products such as cattle or corn.

Most of the participants in the futures markets are commercial or institutional users of the commodities they trade. These hedgers may use the commodity markets to take a position that will reduce the risk of financial loss due to a change in price. Other participants, mainly individuals, are speculators who hope to profit from changes in the price of the futures contract. Speculators typically close out their positions before the contract is due and never take actual delivery of the commodity (e.g. grain, oil, etc.) itself.

Investing in a futures contract will require you to open up a new brokerage account, if you do not have a broker that also trades futures, and to fill out a form acknowledging that you understand the risks associated with futures trading.

Each commodity contract requires a different minimum deposit, depending on the broker, and the value of your account will increase or decrease with the value of the contract. If the value of the contract goes down, you will be subject to a margin call and will be required to place more money into your account to keep the position open. Due to the huge amounts of leverage, small price movements can mean huge returns or losses, and a futures account can be wiped out or doubled in a matter of minutes.

Most futures contracts will also have options associated with them. Options on futures contracts still allow you to invest in the futures contract, but limit your loss to the cost of the option. Options are derivatives and usually do not move point-for-point with the futures contract.

Advantages:

It’s a pure play on the underlying commodity.

Leverage allows for big profits if you are on the right side of the trade.

Minimum-deposit accounts control full-size contracts that you would normally not be able to afford.

You can go long or short easily.

Disadvantages:

The futures markets can be very volatile and direct investment in these markets can be very risky, especially for inexperienced investors.

Leverage magnifies both gains and losses.

A trade can go against you quickly and you could lose your initial deposit (and more) before you are able to close your position.

The Bottom Line

There are different types of commodity investments for novice and experienced traders to consider. Although commodity futures contracts provide the most direct way to participate in price movements, other types of investments with varying risk and investment profiles also provide exposure to the commodities markets. The key is to invest with the tool that works best for you.