Are Commodities High Risk?
Commodities are speculative and wild price moves can happen just as they do with some currency pairs in the Forex trading arena. Therefore, only a small group of people with enough industry exposure can successfully trade them.
The risk that is tied to the commodities market is definitely real. But the potential of reaping big profit is also real because of volatility and risk that exists in the commodities market.
So, are commodities high risk?
Leverage is the double-edged sword
Commodities are traded in the futures market which means that traders often get access to high leverage. Leverage lets a trader control a significant portion of the contract with a small amount of money. In fact, some commodities brokers allow investors to open an account with as little as $2,500.
As a trader utilizing leverage in the commodities market, you’ll need to post between 5%-15% of the contract’s value in the commodities margin value in order to control the contract.
Let’s take this example: assuming a barrel of crude oil is trading at $84 and the futures contract is for $1000 barrels, a trader would need to post about $6000 to control a contract worth $84,000. Also, for every $1 movement in the market, the investor would be gaining or losing $1000 for each contract he is holding.
On a typical day, crude oil’s price can move between $1-$2.5. Being that the trader is gaining or losing $1000 per $1, profits can be lucrative just as risks can be magnified. It is this risk that is attracting some investors to trade commodities. Those who don’t understand how leverage works in the commodities market end up losing especially if they are not disciplined traders.
The difference between a trader who loses money and one who makes money in the futures market is that the latter does not understand the specific market they are trading, their volatility and the level of leverage that works for those markets.
Despite the risk that is in the futures market, Commodity Trading Advisors (CTAs) have been able to demonstrate consistent positive returns over time. Statistics compiled by the Barclay CTA Index indicate that CTAs were able to gain 11.56% in annual returns between 1980 and 2009. However, the worst draw down that was recorded in this duration was -1.19%.
While the risk of losing money if you are a new retail futures trader is high, the fact of the matter is that CTAs have been able to make consistent returns with large pools of money mainly because they diversify risks and at the same time capitalize on various trading strategies.
The futures market is therefore treacherous. You go in only when you understand the risks and have sufficient exposure to the markets before you can expect to make any money. Meanwhile, the risk of leverage is the main focus for futures traders. In the other world of commerce, people deal with other types of risks which may include margin risk, credit risk, market risks and so on.