By: Hillel Fuld
1. When did commodity trading start and how?
The futures commodity market has been around since the rice futures were traded in Japan back in the 18th century. Some historians provide an even earlier date based on findings that primitive Persian societies traded commodities such as olive oil, spices, and more. The United States first saw commodity trading in the mid 19th century with trading of corn in Chicago and Cotton in New York.
With the industrial revolution came a growing need for a higher standard of living as well as a larger quantity of food. The new technology and the ability to developer more efficient tools, kept up with the growing population and eventually called for more agricultural storage, better transport methods, as well as more efficient distribution of goods.
In the beginning the cash markets were able to cope with the growing demands, but the increase in quantity eventually led to the economies dependence on the futures markets with its uniform pricing and delivery. Purchasers of commodities were now able to protect themselves against fluctuating prices that were a result of higher supply during harvest and shortages that occurred prior to harvest.
2. What does a futures contract mean and how is it different than a standard contract?
The majority of commodity trades in the commodity market are sold as a futures contract. What this means is that both sides of the trade agree upon a future date, time, and place for the delivery of the commodity. The price fluctuation that occurs from the day the trade is established until the agreed upon date is where the risk factor plays a role. If the agreed upon price is lower than the market value of the future date, the buyer has made a profit. If the agreed upon price is higher than the future market value, then the seller can benefit from a profit they would otherwise not have seen.
3. Why is the commodity market an attractive investment?
There are various reasons one would invest in the commodity market. A unique characteristic to both Forex and commodity trading is the available leverage. While stock traders can generally purchase a stock worth $10,000 by investing that same amount, in Forex and the commodity market, you can trade with a very low capital and open positions worth ten, 50, and even 400 times that amount. An additional benefit of the commodity market is that unlike the stock of a company, no matter how bad the situation gets, commodities will also retain some value. There is no such thing as a commodity going bankrupt. Lastly, the commoditiy market is regulated by the Commodities Futures Trading Commission as well as the National Futures Association, both bodies responsible for retaining the integrity of the commodities market.
4. What is Hedging and Speculating in Commodity Trading?
These two terms are the principles that guide the commoditiy market. On the one hand, you have hedging, which is the ability to shift your risk. To illustrate this point, we can take an example of a large company selling rice to stores and restaurants. If this large company had to swallow the risk of a decreasing value of rice, they would encounter regular losses and would thereby be forced to raise their prices. If, however, an external player is willing to guarantee a certain price for their rice, irrelevant of the market’s value in the future, that large company can reduce its risk, and thereby reduce its prices. This company is hedging, by transferring the risk of rice value decrease to another player. That other player is speculating. He/she is counting on the fact that the price of rice will in fact increase, thereby guaranteeing a profit I they purchase the rice at the price they are offering. These are the two sides of coin and they are what keep the commoditiy market alive and kicking.
5. Do you actually ever see the commodity you are trading in the commodity market?
In most cases, the commodity you are trading never actually gets seen or handled by either side. In fact, the commodity is not what is really being sold here, but rather a guarantee or a contract to buy or sell the commodity at a future date. Most commodity traders have no intention of buying or selling the actual commodity, but rather profiting from fluctuating prices by going long or short with the commodity of choice.
These are some of the most commonly asked questions when first encountering the commoditiy market. There is a lot more to learn before becoming an expert on this market, but these fundamental principles will give you a head start in your commodity trading.