Commodity futures market allows the commercial producers and consumers to offset the risk which arises out of the movements in prices of the commodities that they trade. Commodity trading exchanges encourage the speculators and this is done so that a liquid market can be facilitated in order to help the consumers and the producers to freely buy or sell contracts. The speculators have one specific objective and it is to make a profit by taking on the price fluctuations which are not generally taken by the consumers. There are possibilities of high rewards for the speculators because the possibility of loss is also substantially high.
Advantages of commodity trading:
There are various advantages of commodity trading which are listed below:
• Margin leverage: Commodities operate on the margin and this means that only a fraction of the total value (in cash) needs to be there in the trading account for taking a position.
• Commission cost: Buying or selling one commodity futures contract is cheaper than buying or selling the underlying instrument.
• Liquidity: Since the speculators are involved in commodity futures trading, the futures contracts are reasonably liquid. However, the contract which is being traded determines the liquidity. For example, e-minis (which are electronically traded contracts) is the most liquid ones whereas the commodities which are pit traded like corn, orange juice etc. are not readily available and are more expensive than the others.
• Commodity futures contracts can be sold as easily as they can be bought. This means that the speculators can very easily make a profit by speculations regarding the falling or rising market.
Disadvantages of commodity trading:
There are several disadvantages as well which are discussed below:
• Margin leverage can also be harmful. In the case of low margins, there are possibilities of poor money management and this can lead to high risk.
• Since traditionally the commodities are pit traded there are risks of spillage and also the time consumed is a factor that needs to be considered.