An Overview Of Commodities Trading
Commodities markets, both historically and in modern times, have had tremendous
economic impact on nations and people. The impact of commodity markets
throughout history is still not fully known, but it has been suggested that rice
futures may have been traded in China as long ago as 6,000 years. Shortages on
critical commodities have sparked wars throughout history (such as in World War
II, when Japan ventured into foreign lands to secure oil and rubber), while
oversupply can have a devastating impact on a region by devaluing the prices of
core commodities.
Energy commodities such as crude are closely watched by countries, corporations
and consumers alike. The average Western consumer can become significantly
impacted by high crude prices. Alternatively, oil-producing countries in the
Middle East (that are largely dependent on petrodollars as their source of income)
can become adversely affected by low crude prices. Unusual disruptions caused
by weather or natural disasters can not only be an impetus for price volatility, but
can also cause regional food shortages. Read on to find out about the role that
various commodities play in the global economy and how investors can turn
economic events into opportunities.
Commodities 101
The four categories of trading commodities include:
Energy (including crude oil, heating oil, natural gas and gasoline)
Metals (including gold, silver, platinum and copper)
Livestock and Meat (including lean hogs, pork bellies, live cattle and feeder cattle)
Agricultural (including corn, soybeans, wheat, rice, cocoa, coffee, cotton and sugar)
Ancient civilizations traded
a wide array of commodities, including livestock, seashells, spices and gold. Although the quality of
product, date of delivery and transportation methods were often unreliable, commodity trading was an
essential business. The might of empires can be viewed as somewhat proportionate to their ability to
create and manage complex trading systems and facilitate commodity trades, as these served as the
wheels of commerce, economic development and taxation for the kingdom's treasuries. Reputation and
reliability were critical underpinnings to secure the trust of ancient investors, traders and suppliers.
Investment Characteristics
Commodity trading in the exchanges can require agreed-upon standards so that trades can be executed
(without visual inspection). You don't want to buy 100 units of cattle only to find out that the cattle are
sick, or discover that the sugar purchased is of inferior or unacceptable quality.
There are other ways in which trading and investing in commodities can be very different from investing
in traditional securities such as stocks and bonds Global economic development, technological
advances and market demands for commodities influence the prices of staples such as oil, aluminum,
copper, sugar and corn. For instance, the emergence of China and India as significant economic
players has contributed to the declining availability of industrial metals, such as steel, for the rest of
the world.
Basic economic principles typically follow the commodities markets: lower supply equals higher prices.
For instance, investors can follow livestock patterns and statistics. Major disruptions in supply, such as
widespread health scares and diseases, can lead to investing plays, given that the long-term demand
for livestock is generally stable and predictable.
Which penny stocks can help you turn $1k to $10k?
The Gold Standard
There is some call for caution, as investing directly in specific commodities can be a risky proposition,
if not downright speculative without the requisite diligence and rationale involved. Some plays are
more popular and sensible in nature. Volatile or bearish markets typically find scared investors
scrambling to transfer money to precious metals such as gold, which has historically been viewed as a
reliable, dependable metal with conveyable value. Investors losing money in the stock market can
create nice returns by trading precious metals. Precious metals can also be used as a hedge against
high inflation or periods of currency devaluation.
Energizing the Market
Energy plays are also common for commodities. Global economic developments and reduced oil outputs from wells
around the world can lead to upward surges in oil prices, as investors weigh and assess limited oil supplies with everincreasing energy demands. However, optimistic outlooks regarding the price of oil should be tempered with certain
considerations. Economic downturns, production changes by the Organization of the Petroleum Exporting Countries
(OPEC) and emerging technological advances (such as wind, solar and biofuel) that aim to supplant (or complement)
crude oil as an energy purveyor should also be considered.
Risky Business
Commodities can quickly become risky investment propositions because they can be affected by eventualities that
are difficult, if not impossible, to predict. These include unusual weather patterns, natural disasters, epidemics and
man-made disasters. For example, grains have a very active trading market and can be volatile during summer
months or periods of weather transitions. Therefore, it may be a good idea to not allocate more than 10% of a
portfolio to commodities (unless genuine insights indicate specific trends or events).
Exchanges
With commodities playing a major and critical role in the global economic markets and affecting the lives of most
people on the planet, there are multitudes of commodity and futures exchanges around the world. Each exchange
carries a few commodities or specializes in a single commodity. For instance, the U.S. Futures Exchange is an
important exchange that only carries energy commodities.
The most popular exchanges include the CME Group, which resulted after the Chicago Mercantile Exchange and
Chicago Board of Trade merged in 2006, Intercontinental Exchange, Kansas City Board of Trade and the London
Metal Exchange.
Futures and Hedging
Futures, forward contracts and hedging are a prevalent practice with commodities. The airline sector is an example of
a large industry that must secure massive amounts of fuel at stable prices for planning purposes. Because of this need,
airline companies engage in hedging and purchase fuel at fixed rates (for a period of time) to avoid the market
volatility of crude and gasoline, which would make their financial statements more volatile and riskier for investors.
Farming cooperatives also utilize this mechanism. Without futures and hedging, volatility in commodities could
cause bankruptcies for businesses that require predictability in managing their expenses. Thus, commodity exchanges
are used by manufacturers and service providers as part of their budgeting process – and the ability to normalize
expenses through the use of forward contracts reduces a lot of cash flow-related headaches.
The Bottom Line
Investing in commodities can quickly degenerate into gambling or speculation when a trader makes uninformed
decisions. However, by using commodity futures or hedging, investors and business planners can secure insurance
against volatile prices. Population growth, combined with limited agricultural supply, can provide opportunities to
ride agricultural price increases. Demands for industrial metals can also lead to opportunities to make money by
betting on future price increases. When markets are unusually volatile or bearish, commodities can also increase in
price and become a (temporary) place to park cash.
Futures Trading Introduction:
A Beginner's Guide
What is Futures Trading?
Futures Trading is a form of investment which involves speculating on the price of
a commodity going up or down in the future.
What is a commodity? Most commodities you see and use every day of your life:
the corn in your morning cereal which you have for breakfast,
the lumber that makes your breakfast-table and chairs
the gold on your watch and jewellery,
the cotton that makes your clothes,
the steel which makes your motor car and the crude oil which runs it and takes you
to work,
the wheat that makes the bread in your lunchtime sandwiches
the beef and potatoes you eat for lunch,
the currency you use to buy all these things...
... All these commodities (and dozens more) are traded between hundreds-ofthousands of investors, every day, all over the world. They are all trying to make a
profit by buying a commodity at a low price and selling at a higher price.
Futures trading is mainly speculative 'paper' investing, i.e. it is rare for the investors
to actually hold the physical commodity, just a piece of paper known as a futures
contract.
What is a Futures Contract?
To the uninitiated, the term contract can be a little off-putting but it is mainly used
because, like a contract, a futures investment has an expiration date. You don't
have to hold the contract until it expires. You can cancel it anytime you like. In
fact, many short-term traders only hold their contracts for a few hours - or even
minutes!
The expiration dates vary between commodities, and you have to choose which
contract fits your market objective.
For example, today is June 30th and you think Gold will rise in price until midAugust. The Gold contracts available are February, April, June, August, October
and December. As it is the end of June and this contract has already expired, you
would probably choose the August or October Gold contract.
The nearer (to expiration) contracts are usually more liquid, i.e. there are more
traders trading them. Therefore, prices are more true and less likely to jump from
one extreme to the other. But if you thought the price of gold would rise until
September, you would choose a further-out contract (October in this case) - a
September contract doesn't exist.
Neither is their a limit on the number of contracts you can trade (within reason there must be enough buyers or sellers to trade with you.) Many larger
traders/investment companies/banks, etc. may trade thousands of contracts at a
time!
All futures contracts are standardised in that they all hold a specified amount and
quality of a commodity. For example, a Pork Bellies futures contract (PB) holds
40,000lbs of pork bellies of a certain size; a Gold futures contract (GC) holds 100
troy ounces of 24 carat gold; and a Crude Oil futures contract holds 1000 barrels
of crude oil of a certain quality.
A Short History of Futures Trading
Before Futures Trading came about, any producer of a commodity (e.g. a farmer
growing wheat or corn) found himself at the mercy of a dealer when it came to
selling his product. The system needed to be legalised in order that a specified
amount and quality of product could be traded between producers and dealers at a
specified date.
Contracts were drawn up between the two parties specifying a certain amount and
quality of a commodity that would be delivered in a particular month...
...Futures trading had begun!
In 1878, a central dealing facility was opened in Chicago, USA where farmers and
dealers could deal in ‘spot’ grain, i.e., immediately deliver their wheat crop for a
cash settlement. Futures trading evolved as farmers and dealers committed to
buying and selling future exchanges of the commodity. For example, a dealer
would agree to buy 5,000 bushels of a specified quality of wheat from the farmer
in June the following year, for a specified price. The farmer knew how much he
would be paid in advance, and the dealer knew his costs.
Until twenty years ago, futures markets consisted of only a few farm products, but
now they have been joined by a huge number of tradable ‘commodities’. As well
as metals like gold, silver and platinum; livestock like pork bellies and cattle;
energies like crude oil and natural gas; foodstuffs like coffee and orange juice; and
industrials like lumber and cotton, modern futures markets include a wide range of
interest-rate instruments, currencies, stocks and other indices such as the Dow
Jones, Nasdaq and S&P 500.
Who Trades Futures?
It didn't take long for businessmen to realise the lucrative investment opportunities
available in these markets. They didn't have to buy or sell the ACTUAL
commodity (wheat or corn, etc.), just the paper-contract that held the commodity.
As long as they exited the contract before the delivery date, the investment would
be purely a paper one. This was the start of futures trading speculation and
investment, and today, around 97% of futures trading is done by speculators.
There are two main types of Futures trader: 'hedgers' and 'speculators'.
A hedger is a producer of the commodity (e.g. a farmer, an oil company, a mining
company) who trades a futures contract to protect himself from future price
changes in his product.
For example, if a farmer thinks the price of wheat is going to fall by harvest time, he
can sell a futures contract in wheat. (You can enter a trade by selling a futures
contract first, and then exit the trade later by buying it.) That way, if the cash
price of wheat does fall by harvest time, costing the farmer money, he will make
back the cash-loss by profiting on the short-sale of the futures contract. He ‘sold’
at a high price and exited the contract by ‘buying’ at a lower price a few months
later, therefore making a profit on the futures trade.
Other hedgers of futures contracts include banks, insurance companies and pension
fund companies who use futures to hedge against any fluctuations in the cash
price of their products at future dates.
Speculators include independent floor traders and private investors. Usually, they
don’t have any connection with the cash commodity and simply try to (a) make a
profit buying a futures contract they expect to rise in price or (b) sell a futures
contract they expect to fall in price.
In other words, they invest in futures in the same way they might invest in stocks
and shares - by buying at a low price and selling at a higher price.
The Advantages of Trading Futures
Trading futures contracts have several advantages over other investments:
1. Futures are highly leveraged investments. To ‘own’ a futures contract an investor only has to put up a
small fraction of the value of the contract (usually around 10%) as ‘margin’. In other words, the
investor can trade a much larger amount of the commodity than if he bought it outright, so if he has
predicted the market movement correctly, his profits will be multiplied (ten-fold on a 10% deposit).
This is an excellent return compared to buying a physical commodity like gold bars, coins or mining
stocks.
The margin required to hold a futures contract is not a down payment but a form of security bond. If the
market goes against the trader's position, he may lose some, all, or possibly more than the margin he
has put up. But if the market goes with the trader's position, he makes a profit and he gets his margin
back.
For example, say you believe gold in undervalued and you think prices will rise. You have $3000 to
invest - enough to purchase:
10 ounces of gold (at $300/ounce),
or 100 shares in a mining company (priced at $30 each),
or enough margin to cover 2 futures contracts. (Each Gold futures contract holds 100 ounces of gold,
which is effectively what you 'own' and are speculating with. One-hundred ounces multiplied by threehundred dollars equals a value of $30,000 per contract. You have enough to cover two contracts and
therefore speculate with $60,000 of gold!)
Two months later, gold has rocketed 20%. Your 10 ounces of gold and your company shares would now
be worth $3600 - a $600 profit; 20% of $3000. But your futures contracts are now worth a staggering
$72,000 - 20% up on $60,000.
Instead of a measly $600 profit, you've made a massive $12,000 profit!
2. Speculating with futures contracts is basically a paper investment. You don’t have to literally store 3
tons of gold in your garden shed, 15,000 litres of orange juice in your driveway, or have 500 live hogs
running around your back garden!
The actual commodity being traded in the contract is only exchanged on the rare occasions when delivery
of the contract takes place (i.e. between producers and dealers – the 'hedgers' mentioned earlier on). In
the case of a speculator (such as yourself), a futures trade is purely a paper transaction and the term
'contract' is used mainly because of the expiration date being similar to a ‘contract’.
3. An investor can make money more quickly on a futures trade. Firstly, because he is trading with
around ten-times as much of the commodity secured with his margin, and secondly, because futures
markets tend to move more quickly than cash markets. (Similarly, an investor can lose money more
quickly if his judgement is incorrect, although losses can be minimised with Stop-Loss Orders. My
trading method specialises in placing stop-loss orders to maximum effect.)
4. Futures trading markets are usually fairer than other markets
(like stocks and shares) because it is harder to get ‘inside information’. The open
out-cry trading pits -- lots of men in yellow jackets waving their hands in the air
shouting "Buy! Buy!" or "Sell! Sell!" -- offers a very public, efficient market
place. Also, any official market reports are released at the end of a trading session
so everyone has a chance to take them into account before trading begins again
the following day.
5. Most futures markets are very liquid,
i.e. there are huge amounts of contracts traded every day. This ensures that market
orders can be placed very quickly as there are always buyers and sellers of a
commodity. For this reason, it is unusual for prices to suddenly jump to a
completely different level, especially on the nearer contracts (those which will
expire in the next few weeks or months).
6. Commission charges are small
compared to other investments and are paid after the position has ended.
Commissions vary widely depending on the level of service given by the broker.
Online trading commissions can be as low as $5 per side. Full service brokers who
can advise on positions can be around $40-$50 per trade. Managed trading
commissions, where a broker controls entering and exiting positions at his
discretion, can be up to $200 per trade.
In the next section:
Why Leverage is the Biggest Advantage is
also the biggest Disadvantage in Futures
Trading
How to Protect Profits with Stop-Loss
Orders
Where to find Market Information
Futures Trading Introduction (Part 2)
Why Leverage is the Biggest Advantage and the Biggest Disadvantage
The main advantage and disadvantage in futures trading is the leverage involved.
(You can hold a very large amount of a commodity for a small deposit so any
gains and losses are multiplied.) This is the main difference between futures
trading and, say, speculating with stocks and shares.
For example, you have $3000 to invest. You could buy $3000 of shares in an Oil
Mining Company, buying them outright. Or this $3000 may be sufficient margin
(a goodwill "security bond") to buy a couple of Crude Oil futures contracts worth
$30,000.
The price of Crude Oil drops 10%. If this effects the price of your mining stocks by
10%, you would lose $300 (10% of $3000). But this 10% fall on the value of your
Crude Oil futures contracts would lose $3000 (10% of $30,000). In other words,
all of your initial stake would be lost trading the futures rather than only 10% of
your capital trading the shares.
But, with Stop-Loss Orders you will always know how much money you are
risking in any trade.
A Stop Loss Order is a pre-determined exiting point which automatically exits your
position should the market go against you. In the above example, you may only
decide to risk $1000 on the Crude Oil futures contracts. You would place a stop
loss just under the market price and if the market dropped slightly, your position
would be exited for the $1000 loss.
So Leverage is great if the market goes in your predicted direction - you could
quickly double, treble or quadruple your initial stake. But if the market goes
against you, you could lose a lot of money just as quickly. All of your initial stake
(your margin) could be wiped out in a few days. And in some cases, you may have
to pay more money to your broker if the margin you have put up is less than the
loss of your trade.
How to Protect Profits with Stop-Loss Orders
As mentioned above, losses can accumulate just as quickly as profits in futures
trading. Nearly every successful trader uses Stop-Loss Orders in his trading to
ensure profits are 'locked in' and losses are minimised.
How do Stop-Losses work?
A stop-loss is usually placed when a trade is entered, although it can be entered or
moved at any time. It is placed slightly below or above the current market price,
depending on whether you are buying or selling.
For example, say Pork Bellies is trading at $55.00 and you think prices are about to
rise. You decide to buy one Pork Bellies contract, but you don't want to risk more
than $800 on the trade. A one-cent move in the market is worth $4.00 on a pork
bellies futures contract so, therefore, you would place your stop at $53.00 (200
cents away from the current price x $4 per point = $800).
You can also move a stop-loss order to protect any profits you accumulate.
Taking the Pork Bellies example: Two weeks later, bellies are now trading at $65.00.
You are now up $4000 (1000 cents of movement x $4). To protect these profits,
you can raise your stop-loss simply by calling your broker. Say you place it at
$63.00, you have locked it a profit of at least $3200 and now risk $800 to your
new stop level.
But what if the market went against you?
Going back to the original position when you bought at $55.00 with a stop at $53.00:
what happens if the market suddenly tumbles down to $51.00 during the day?
Your trade would automatically be 'stopped out' at your stop level of $53.00 for an
$800 loss. The fact that the market closed the day at $51.00 is irrelevant as you
are now out of the market. (Had you not used a stop-loss and viewed the market at
the end of the day, you would have large losses on your hands!)
The same would happen if the market reached $65.00 and you had raised your stop
to $63.00: If the market fell from here, say to $62.80, you would be stopped out at
$63.00 and would have a profit of $3200. Even if the market suddenly reversed
here and rose to $79.00, this would be irrelevant as you are now out of the market.
This last example would be annoying because if you hadn't been stopped out, you
would now be $9600 in profit. But you were stopped out at your $63.00 stop. The
market only went 20-cents under this and reversed!
It is for this reason that some traders don't use stops: they have been stopped out in
the past JUST when the market was about to go their way.
The solution is not to abandon using stops as this is EXTREMELY RISKY. The
solution is to use stops effectively.
(In fast moving markets it is sometimes impossible for brokers to get your orders
exited exactly on your stop loss limits. They are legally required to do their best,
but if the price in the trading pit suddenly jumps over your limit, you may be
required to settle the difference. In the above scenario, the price of Pork Bellies
could open trading at $62.50, fifty cents through your stop at $63.00. Your broker
would have to exit your trade here and, in fact, you would lose $1000, $200 more
than your anticipated $800.)
Where to Get Market Information
Commodity prices can change direction much faster than other investments, such as company
stocks. Therefore, it is important for traders to stay on top of market announcements.
Professional traders may use a wide number of techniques to do this, using fundamental
information and technical indicators.
Fundamental data may include government reports of weather, crop sizes, livestock numbers,
producer’s figures, money supply and interest rates. Other fundamental news that could
affect a commodity might be news of an outbreak of war.
Technical indicators are mathematical tools used to plot market prices and behaviour patterns
on a graph. These can include trend lines, over-bought and over-sold indicators, moving
averages, momentum indicators, Elliott wave analysis and Gann theory.
Some traders use just one of these basic methods religiously, disregarding the other
completely. Others use a combination of the two.
Many investors, especially smaller investors, devise their own trading method or purchase one
from another trader. (Be careful not to buy a system that has been over-optimised and
curve-fitted to fit past data. Many times, I have seen systems claiming 80%+ winning
trades on past data, but when I have run the system on current prices, the results are
breakeven at best!)
They normally paper trade the method (i.e. they follow the markets but only pretend to place
the trades) for a few months to make sure the method works for them before placing any
actual trades.
Tracking price charts and keeping up with fundamental data is a difficult full-time job – some
large organisations employ dozens of staff to follow market moves. And some traders,
especially those on the market floor, may only hold a position for a few hours or even
minutes.
So where does this leave the small, independent investor who would like to trade in the
lucrative futures markets?
Many trade on a daily or weekly basis, i.e. they note or 'download' market prices at the end of
each trading day and make their decisions from this data. Often, they will leave a trade on
for at least a few weeks (possibly months). This is a much SAFER way of trading because
any fluctuations are ridden out and less panic-buying or selling is involved.
In the next section:
Futures Contracts for Beginners
Futures Trading Alternatives
Smaller Futures Contracts
Spread Betting
Options Trading
Futures Contracts for Beginners
If you have a limited amount of capital to invest, you probably can't afford to trade
the larger contracts like the Nasdaq and S&P500 as a slight percentage move
could be worth thousands of dollars. But there are still plenty of smaller and less
expensive contracts you can trade.
All futures contracts have standardised amounts of the commodity which are held
by them. For example, if you buy a single pork bellies contract, you are ‘holding’
the value of 40,000lbs of pork bellies. If you sell a single soybeans contract you
are betting on the value of 5000 bushels of soybeans.
Each point-move on a particular contract is worth a specific amount, and these
amounts vary between contracts. For example, a 1-cent move on a Pork Bellies
contract is worth $4, so a move in the market from $60.00 to $61.50 would be
worth $600 per contract ($4 x 150 cents). In Soybeans, a 1-cent move in the
market is worth $50 so a jump from $500 to $505 is worth $250 ($50 x 5c).
Some contracts are worth a lot more than others, especially if they are trading at historically
high prices. For example, at the time of writing, the Nasdaq Index moved up around 10%
last month – worth nearly $50,000 per contract! (It is at an all time high, 20 times higher
than 10 years ago.) But Wheat dropped around 10% per contract - worth about $1250 per
contract. (It is at its lowest price for years.)
Beginners need to first establish if they can afford to trade the commodity - if they have
enough margin in their account to cover the trade, and if they can afford a sizeable move
against their position. (Some traders such as Larry Williams and Tom Basso feel that
risking approximately 3% to 5% of total trading capital on a position is about right.
Remember too, that these traders are some of the best in the world - if you are a beginning
trader, you should be careful risking that much!) Your broker will probably give you a list
of dollar-per-point ratios for all the different contracts, as well as their commission and
margin requirements.
A trader also needs to establish the risk/reward of trading on any particular commodity - how
much you are risking to your stop loss and how much you intend to win to your target
price. (Alternatively, work out the average loss and profit made by your trading system to
find the expectancy of a trade's profits.)
It is also important for traders to spread the risk of trading by using different types of
commodity. For example, just because you have enough capital to trade 5 contracts, don't
buy five energy contracts just because they have the largest risk/reward ratio. Instead,
spread your risk by trading some grains, some metal, some energy, some livestock and
some currency (if they are potentially rewarding).
You may also buy or sell more than one contract on each commodity to keep the risk
balanced. For example, a Pork Bellies contract may be worth a lot more than a Soybeans
contract. You may decide to buy two Pork Bellies contracts and six Soybeans contracts to
keep the values held on each market about equal.
None of your trades should risk more than 5% of your trading capital if possible. (And in
"trading capital", I mean money you can afford to, and are prepared to LOSE!) That way,
you would have to lose 20 trades in a row in order to get wiped out.
Futures Trading Alternatives
Speculating on the commodity markets can certainly be an excellent form of
investment. But it can require a large amount of capital to speculate effectively
on the futures markets. To set up the smallest futures account normally requires at
least $5000, and many brokers require proof that you can afford to pay any losses
greater than the funds in your account. (In case the market suddenly drops below
your stop-loss level.)
Also, even the smallest futures contracts require at least $1000-$3000 in margin for
you to hold them. This means a speculator with a $5000 account may only be able
to trade one or two markets at a time. Many top traders recommend spreading
your risk between several markets at a time. And, as mentioned above, you should
only risk up to 5% of your trading capital on any position.
So if you haven't got $20,000 or $100,000 to speculate with, what are your options?
Smaller Futures Contracts
Most of the widely traded futures contracts are large contracts traded on the
Chicago Board of Trade, The Chicago Mercantile Exchange or the New York
Mercantile Exchange. But there are also other exchanges that trade much
smaller futures contracts.
For example, the MIDAM exchange (Mid-America) trades most of the major
commodity and currency markets but under smaller contracts. Typically they hold
one-fifth to one-half the amount of the commodity of the more popular contracts
meaning the risks and margin requirements are a lot less.
Other exchanges around the world trade smaller futures contracts of various
commodities, such as Brent Crude Oil on the LPE, London Wheat on LIFFE, and
Copper, Aluminium and Tin on the LME.
Spread Betting
Spread betting is a relatively new approach of trading the futures markets. A spread betting
company, such as IG Index, Financial Spreads, or City Index doesn’t charge a commission
but gets paid on a ‘spread’ of the market price. This is usually a couple of points either side
of the actual market price, like an ask/bid spread.
For example, say the March Gold contract is trading at $300 per ounce. Depending on which
way you wanted to trade, you may be quoted 298/302.
If you were buying you would enter at $302 – two points above the market price.
If you wanted to sell, you would enter at $298 - two points under the market price.
Both the spreads go against your market direction. If the value of one point on the contract
was $100, in effect you would be paying a 2 point spread worth $200.
This is quite a lot more expensive than a normal futures brokerage’s commission charge and
an exchange's ask/bid charge, and it can be even higher if you place a stop-loss order.
(Therefore, spread betting is more suited to long-term trading and not short-term day
trading - high commissions will take away any profits.)
But the value of a spread betting ‘contract’ can be around half that of a real futures contract.
Therefore, the amount of money you need to put into an account, to bet on a commodity, or
the amount you can lose, is about half that of trading a real contract. You can often put a
guaranteed stop loss order on your bet, too, which avoids the pitfalls of 'gapping' prices.
(For example, say you were long on Gold and your stop-loss was at 290. The market
opened well down at 285, you would be stopped at 290 with your guaranteed stop. Trading
a normal futures contract, your broker would have to stop you out at 285 and you would
lose an extra $500.)
FinSpreads.com allow you to start trading futures from only 1 penny per point. This compares
with $250 per point on the S&P500, so it is an easy way for a small investor to start futures
trading. However, spread betting is only available to UK and some European residents....
and is not available in the USA.
Also, any profits you make from a spread-bet will be free from capital gains tax.
Options Trading
Options trading is available on a number of investments including futures contracts.
Options trading is a complete subject in itself and can be more complicated that
futures trading to understand. But basically, using an option gives a trader the
right to buy or sell a contract at a future date, but not the obligation.
The trader needs to pay a premium for this choice which can often work out less
expensive than the margin requirements - or the risk to a stop-loss order - in
trading the futures contract. Should the trader not exercise the option, he would
lose the premium he paid for the option. But should he exercise it, he could make
a lot of money.
There is a lot of terminology in options trading and it can be more complex than the
simple 'buy or sell' method of futures trading. Should you be interested in it, there
are plenty of options books available.
Managed Futures Trading
It has been reported that up to 95% of investors speculating on futures markets end
up losing money (source: Bridge Trader magazine). The reasons for this could be
that many naiive investors become enticed by the potential huge rewards
associated with futures, when they are ill-prepared to compete with the thousands
of professional traders, some with decades of experience, access to the trading
pits, the use of million dollar technology, etc.
The markets can be cruel, and you should be prepared for the worst.
An alternative is to use the skills of professional traders who can manage your
account to trade the exciting futures markets. This is known as Managed Futures
Trading. A Commodity Trading Advisor (CTA) can be used to trade a client's
funds under Power of Attorney. Computerized trading systems can also be used in
order to stick rigidly to a trading system.
Summary
Yes, you can start trading futures with a $5000 account - and
even less to cover a trade on a spread bet. But you should
have a lot more than this in expendable income.
Speculating with absolute minimum capital is renowned for its
'have to win' pressure. And this emotion will making trading
extremely difficult. If you lost 2, 3, 4 or even 5 trades in
succession, would you have the courage to be able to place
the next trade? If you have a small trading account this
could be wiped out in a small number of losing trades.
Even one losing trade can do a lot of damage. For example, if
you lose 50% of your trading capital in a few trades, you
have to make 100% return on what is left to get back to
even.