Have you ever heard investors mention speculating in futures of the commodity market and wondered what it they are talking about? While most of us are familiar with investing in stocks, commodities can be an interesting way to have your money make money for you.
But first, you might ask what is a commodity? commodities are goods we are each one portion is the same as the other. For examplee, oil is a commodity because one barrel of oil is the same as the next. Wheat is also a commodity each bushel of wheat is identical to every other bushel of wheat and anyone purchasing them could care less whether they get bushel number one or bushel number two. Gold is another example of a commodity. 1 ounce of gold is the same as the next.
There are some differences in some commodities to external forces such as shipping costs or differences in composition. For example, not all oil sells for the same cost because they may come from different sources were shipping is a consideration. Also they may trade on different markets where the pricing is different.
There are two ways that commodities are traded, in spot markets, or as futures.
Spot markets, refer to trades that take place literally on the spot. The commodity is traded right then and there, usually for cash but also could be for some other product or good. For example, if you want to buy an ounce of silver, you can go right down to the jeweler give him some cash and it will give you so. This is spot trading.
Of course, spot trading can be done in larger volume as well. Some traders exchange millions of ounces of silver or thousands of barrels of oil and then sometime later the actual goods are delivered.
When traders talk about futures or options it is not the actual good that is traded for rather a contract to buy or sell that particular commodity for a particular price a certain date in the future. This is how most commodities trading is done. This type of trading can have huge profits and also huge losses as it involves speculating on the future which can be full of risk and uncertainty.
this type of trading has been around in its present form since the late 18th century . Around this time farming became more modernized which allowed commodity trading to be profitable. Although this is an age-old way of making money, the basics remain the same today as they were in the late 1700’s.
For example, wheat takes many months to grow. So at the beginning of the planning, the market price when the wheat is ready and speculated on. So if a farmer plants meet in May which will be delivered in September, the price at that time may be four dollars a bushel. If in June the price begins to fall, and the farmer feels the price will continue following, he may offer a contract on this week for the current price (lower than $4.00). Now if someone thinks that the price will go up over four dollars, then this contract will look like a pretty good deal and they may take them up on it.
Since no one knows for sure what that price will be, an actual prices based on such unpredictable things such as weather, this whole process Is called speculation. so now when September rolls around, the farmer delivers his wheat for the agreed on price. Now if the price has actually gone up to over four dollars and the speculator has made a profit. But, if in fact, it is fallen to wander the agreed-upon price he has lost money.
So there you have it, the basics of commodity trading.