Trading commodities such as corn, wheat and soybeans is among the most complex forms of investing. For that reason, experts warn strongly against novices entering the venue.
These types of trades can offer the most rewards--as well as the most risks--due to wild price fluctuations.
Investors almost never buy or sell commodities outright. Instead, they buy a contract to either buy or sell the commodity at a future date and set price. This is known as a futures contract.
Most investors usually sell the contract before the delivery date because they don't actually want to own the commodity. They're just betting on which way prices will move. A "long" contract means the investor thinks prices will rise, while a "short" contract is a bet that prices will fall.
Let's say you purchase a contract to buy wheat in April for $10 a bushel. If the price of wheat rises above $10, you're going to make a profit. But if the price falls below $10, you'll lose money.
Some basic facts about trading in commodities futures:
- The most commonly traded agricultural commodities are corn, soybeans, wheat, oats, rice and cotton.
- Trading can be done either through a broker or through online trading systems.
- To buy a contract, investors generally are required to put down a portion of the contract's value. These minimums--which are known as margin buying--can vary greatly. Holding a corn contract, for instance, costs $1,000, while holding a Standard & Poor's 500 commodities contract costs $10,000.
- If commodities prices change enough to make the value of your contract worth less, you may be required to put up more money to hold onto the contract.
- As trading develops, contract holders either reap profits or pay losses, depending on which way the contract moves and whether the investor is holding a long or short position.
- Traders can minimize their exposure by ordering an offset, which would limit losses in case the commodity hits a particular price point. It's important to monitor the rapid fluctuations in prices to minimize losses that aren't covered by offset trades.
- It isn't necessary to purchase futures to trade commodities. Exchange-traded funds have issues that imitate the movements of various commodities, without the risks and rewards of futures trading.