Dealing with commodities is an old profession which dates back further than stocks and bonds. Commodities, whether they are related to metals, energy or agriculture, is an important part of everyday life. Basic economic principles of demand and supply typically drive the commodities markets, lower supply drives up demand, which equals higher prices, and vice versa.
Today, tradable commodities fall into mostly four categories, metals, energy, livestock and agricultural. There are many ways to invest in commodities including exchange trade funds, mutual funds and hedge funds. Investors can also gain exposure by investing in mining and other commodity related companies through stocks. The most popular way to invest in commodities, however, is through a futures contract – an agreement to buy or sell the underlying commodity at a specified future date and price. Each futures contract represents a specific amount of a given commodity.
It’s important to note that futures contracts have specific expiration dates, and if you don’t exit your position before that date, you’ll either have to deliver the physical commodity or take delivery. Trading in commodity futures contracts can be very risky for the inexperienced. One cause of this risk is the high amount of leverage involved in holding futures contracts. Unlike options, futures are the obligation of the purchase or sale of the underlying asset.
Simply not closing an existing position could result in an inexperienced investor taking delivery of a large quantity of an unwanted commodity. Speculation using short positions in futures can lead to unlimited losses.
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