Massive misinformation among the vast population is that commodity trading is pretty much a safe bet. However, the truth is far from it, as commodity trading involves lots of risks. These risks can be attributed to various factors such as fluctuating prices of commodities due to interdependencies and more. With that being said, if your goal is to invest in safe options, then having your money parked in the bank is the only option.
Commodity trading is a great mechanism to maximize your investment and diversify your portfolio. But, thanks to the risks involved in the commodity market, it is best advised to learn and do your research before you set your foot in it. Here are five tips that can help you with your venture in commodity trading.
Use your leverage wisely:
When trading commodities, keep in mind that the level of leverage is substantially higher. The margin paid in this scenario is what we refer to as leverage in this context. When using leverage in commodities trading, there are two factors to keep in mind. First, you must choose the most significant amount of funds you are willing to lose and then trade appropriately. Second, just as profits can be magnified in leverage positions, losses can be magnified as well. As a result, it’s critical to manage your commodity leverage carefully.
For example, if you take a long or short position in index futures, you’ll have to pay roughly 10% margin (that’s ten times leverage), while stock futures will cost you around 15% margin (that means leverage of 6.66 times). When it comes to commodities, the leverage available is significantly greater. In many circumstances, the leverage is as high as 14-16 times. However, you can enhance your leverage if you play your cards right by putting cover orders with an in-built stop loss.
Follow the trend:
While this is a tip that applies to all forms of trading, it must be followed with extra vigor for commodity trading. Commodities, on the whole, tend to follow larger cycles and sub-cycles. Within these more extensive cycles, there will undoubtedly be periods of volatility.
However, it would be best if you recognized this pattern and trade within its confines. A contrarian strategy can be pretty beneficial in inequities, but it may be pretty beneficial in commodities trading. Because commodities are more homogeneous than equities, catching the underlying trend and trading in the same direction is the key to success.
Go for stop losses over average losers:
There are two significant reasons for the stop losses in commodities trading. The first reason being commodities are highly leveraged and positions on low margins; hence it is essential to have strict stop losses to avoid incurring losses. The second reason being, stop losses will ensure that you do not get over-attached to any particular commodity. This makes you avoid making decisions in favor of that particular commodity, thereby increasing your risk.
Avoid the temptation of averaging your losers, which follows as a natural sequel to this statement. For example, you may have purchased gold at higher prices and may be tempted to average your position at lower values. After examining the trend, it is preferable to depart your old position and take a fresh look.
Stay away from Overtrading:
The majority of traders engage in trading primarily for the adrenaline high it delivers. That is not a very wise decision. You’re more likely to make suboptimal decisions and wind up overtrading if you get carried away in the heat of the moment. When you’re an aggressive trader, you’re tempted to overtrade to make up for your losses. But, in Commodity trading, things do work differently.
If you try to trade to recover your losses, you’ll end up overtrading in the commodity market, incurring higher transaction costs and no increase in the profitability of your positions. Ensure you never receive a margin call from the exchange, which implies you must carefully manage your risks.
Maintain a goal to conserve your capital:
It doesn’t matter if you’re trading stocks, futures, options, or commodities; it’s all about sticking to a strategy. When we talk about a trading plan, we refer to a collection of guidelines that will serve as a roadmap for your trading. You must establish standards for the maximum amount of exposure you will take in a specific commodity position.
Your trading strategy will include how much you’re willing to lose in a single trade, a day, and a week. Your trading strategy must also specify how you will conserve capital and when you will convert to a cash-based trading strategy. The trading plan will specify when you will grow or decrease your cash position. Commodity trading is all about risk management. Thus the most important thing to remember is to keep your money safe. Your task is already half done when you manage to accomplish that and trade with discipline and according to a plan.
Trading in commodities is not very much different from dealing with equities. All you need to know is the nuances involved, and you can walk your way to the bank with a happy face. Apart from knowing the fundamentals and nuances of commodity trading, the brokerage firm and the online platform you choose for trading also play an essential role.