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4 Myths About Trading Commodities

Research suggests that we are in the beginnings of a commodities supercycle. What this means is that the broad category of commodities will experience rising prices over the next few years and possibly decades. This is driven by a supra-secular decline in interest rates, which has flooded the market with easy money; tightening supply coupled with rising demand from emerging markets; expansionary fiscal policy and other factors. Yet, despite this market opportunity, many investors are skittish about investing in commodities. This is due to various myths that have poisoned the well. In this article, we will tackle 4 myths about trading commodities.

There is Excessive Volatility in Commodities

Trading in commodities is unique because you can use leverage in ways that are just unimaginable when trading stocks. For instance, when trading stocks, you need at least 50% in margin. This means that your broker loans you half the value of the stock if you put 50% down payment for the stock. However, when trading commodities futures, you only need to put down 3-15% margin. This means that your potential returns are enormous compared to when trading stocks. This attracts many novice traders who treat this gift with wild abandon. Now, once you take out leverage, the reality is that commodities are no more volatile than stocks. The volatility many people observe is a function of leverage.

Physical Delivery is a Must

Commodities give people the illusion that they need to take physical delivery. There are stories of people receiving shipments of cotton or barrels of oil after taking on a futures contract. Yet, in every futures contract, you can simply state that you want to settle the contract with cash, not physical delivery. If you don’t want the physical product, just tick a box. It’s that simple. In fact, most futures contracts are for cash settlement. If you are interested in physical delivery, then you should work with firms such as Regal Assets who have incredible storage solutions and offer great customer experience.

You Need a Fortune to Trade Commodities

People seem to think that you need a fortune to invest in commodities. Yet, many brokers allow you to open a brokerage account with as little as $5000. Many will allow you to open a brokerage account with just $2500. Now, an important rule of investing is to never invest what you can’t afford to lose. This capital should be risk capital. Investment is not a sure thing.

Everybody Makes a Loss

This is perhaps a side-effect of believing that volatility in commodities is excessive. Making money from stocks is more popular than making money in commodities. Every investor can name a great stock investor but few can name a great commodities investor. This illusion of the losses on commodities trading floors leaves many people wary of trading commodities.

Yet, the losers are usually ill-prepared novices seduced by the leverage on offer into making crazy bets. Now, because commodities investing is a zero-sum game, you have to figure that for every loser there is a winner. The market can’t be made up of losers. It’s just a mathematical fact. 

Adriaan Brits

Adriaan Brits is a multi-sector analyst and business consultant with notable commentary on the S&P500. He loves to evaluate fast-movers and to be ahead of the trend.

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