Investing in commodities can offer your portfolio many rewards for your effort.  Although some investors consider trading commodities a riskier venture than trading stocks, there are several strategies you can implement to keep commodity trading at a conservative risk level.  With commodities, you can essentially learn to raise or the lower the level of the risk to suit your tastes.  If you keep your commodity trading at a conservative level, you can earn decent returns for your portfolio.

The underlying basics of commodities trading

The trading of commodities has its own risks, but the rewards can be quite lucrative.  Many Wall Street stories circulate about savvy investors who have increased their initial investment 10,000 times or more through trading commodities.  These examples are of course extreme examples, but they illustrate the potential for profits in commodities.  Remember the 1983 film, Trading Places, with Eddie Murphy and Dan Aykroyd which parodied commodity trading and exaggerated the market? It isn’t like that.

The main difference between trading commodities and trading stocks or bonds is that you never actually own something although, like options, you do own the right to buy or sell a large amount of something.  You are speculating on the whether the price of the commodity will go up or down in the future. Commodity trading started as a way to hedge against swings in the price of certain agricultural goods such as corn and wheat. “Buy” and “sell” are loosely used to suggest the direction you think that future price will go.

Trading commodities also allows companies to lock in a price by selling futures.  For example, let us review the oil market.  If prices look like they will decrease, a refinery company may sell with the hopes they can later buy and deliver the gasoline at a lower or at least not higher price.  If the prices appear like they are increasing, a refinery may buy to lock in the oil that they will need to make gasoline in the future. Most major users of commodities, such as major oil companies, own a seat on the commodities exchange (CFTC) and trade their own accounts.

Investors and traders who trade commodities strictly as an investment strategy have to look at the market forces and hope they interpret them correctly.  As an investor, you have to keep an eye on the market and see where you can gain an advantage by buying or selling. Just remember that the closer you are to the floor of the commodities exchange, the better the chance you have of being informed enough to make money as the market moves.

Strategically trading commodities

There is always the risk of losing money if the market turns against your investment.  However, you can avoid large amounts of risk when trading commodities by simply altering your investment style.

First, keep things conservative – basing your investment on greed or fear can cause you to make foolish mistakes.  While you may not see a huge initial return, a conservative approach is more likely to make you a profit in the long run.

Next, make sure you conduct your research.  Knowing the history of a commodity and what conditions influence its price will allow you to make better trading decisions.  Also, if you offset or close-out your position before a delivery date, then you can improve your position instead of taking a loss.  However, in order to do so, you must learn to read the market, which takes time and experience.

Lastly, have a strategic trading system.  There are systems that have a long-term track record of being able to track commodities and predict what will happen to them in the future.  This is a more conservative move, but it does place you in the position to earn a higher profit in the long term.

All in all, the majority of risk in commodities trading comes from an investor that does not know what he or she is doing.  By learning the market and developing a conservative plan, you can reap the rewards of commodities trading for your portfolio.