Commodities trading (or investing) is the buying and selling raw materials such as agricultural products, livestock and meat, energy products and metals in bulk. Sometimes it involves the physical trading of goods. But more often it happens through futures contracts, where you agree to buy or sell a commodity for a certain price at a specified date. Investors rarely intend on taking ownership of the asset.
These commodities can be broken down into two categories, hard and soft. Hard commodities, like gold, require mining or drilling to find. Soft commodities are grown or ranched.
The raw materials can add diversification to your portfolio and provide an inflation hedge, but they're highly volatile because factors like weather events and political strife often make it difficult to predict their impact on prices.
Commodities traders/investors bet on how the commodity's price will move. If you think the price of a commodity will go up, you buy futures, or go long. If you think the price will drop, you sell futures, or go short. Much of it amounts to speculation.
Commodity trading most commonly takes place through futures contracts which specify the terms of delivery of an asset for a specified date in the future. They're often used by producers or major industrial consumers as a risk management tool in case prices increase or decrease.
Futures contracts are typically traded on commodity exchanges. The two largest exchanges in the U.S. are the Chicago Mercantile Exchange and the New York Mercantile Exchange.
When you trade futures, you're required to maintain a certain amount of capital, known as margin, in your brokerage account. When you trade on margin, you're trading borrowed money, which can amplify your losses. It's essential to have enough resources on hand to cover any margin call.
Investors can invest in gold in multiple ways including buying physical gold, futures, stocks, ETFs and mutual funds.
To invest in gold directly, investors can hold it in physical form, which can be done through the purchase of gold bullion bars, gold coins, jewelry.
To invest in gold indirectly, they can choose to buy stocks of gold mining companies, buy shares of an ETF designed to track the price of gold, purchase shares of a mutual fund invested in stocks of companies associated with the mining of gold, through options or futures which create exposure to gold. The position could be closed before expiration or rolled over to a new contract.
The owner of an option has the right, but not the obligation, to buy (call option) or sell (put option) an asset that is linked to gold, such as an ETF.
In general, commodities are significantly more volatile than stocks or bonds. They offer diversification to a portfolio since they usually have a negative correlation with equities.
To research gold, seek out independent and objective gold and precious metals news outlets.
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