Trading commodities online is a relatively simple process, but it is not an activity that should be pursued without doing a lot of homework.
Choosing a Commodity Broker
Commodities are currently traded either by using exchange-traded funds or by buying and selling futures contracts. Many online retail brokers offer trading in both of these types of securities; however, some brokers specialize in futures trading. You should research both types and determine whether you want the added services and tools that come from brokers offering specialized futures trading, as these items come at an additional cost. Other online brokers, such as Interactive Brokers, offer excellent products, good service, and low commission rates.
Commodity Account Documentation
Each commodity broker requires documentation to open an account. The forms require you to disclose financial information and outline the risks involved in trading commodities.
Financial data is critical because commodities are assets that are leveraged (borrowed funds for financing). Thus, there is always the risk of losing more money than the initial investment. Therefore, the broker will require information about income, net worth, and creditworthiness to determine whether they are willing to work with you.
Sufficient income, trading experience, and credit are crucial factors when the broker considers your suitability. Not everyone who completes the account forms is suitable for opening a commodity account. The broker may use discretion in determining whether the prospective client represents an acceptable risk and is suitable for commodity trading.
Before You Start Trading Commodities Online
Once you have chosen an online commodity broker and received approval to trade, the next step is to fund the account. While many brokers set minimum limits, it is up to the individual to determine the amount of funding above the required minimum when opening an account. Personal comfort level and risk tolerance are important considerations when funding the account.
Before you begin trading with real money, it is important to create a trading plan based on thorough research. Many commodity brokers offer simulation training before putting capital to work. Training and simulations will familiarize you with how to place orders and can save you from making critical mistakes when entering orders.
Simulations also help develop your trading intuition and assist you in creating a plan to tackle the markets you wish to trade in.
When you begin trading commodities online, choose your trades wisely and avoid overtrading. Start with small trades and work with one trade at a time. If you find yourself placing multiple trades right off the bat, you may be entering too aggressively, increasing the likelihood of failure and losing money.
Tips for New Online Commodity Traders
It is important to understand what makes up the futures and options markets. These are derivatives of the actual commodity market, where the physical commodities are delivered. A derivative is simply a security based on an underlying asset, in this case, the physical commodities.
Therefore, it is essential to learn everything you can about the fundamentals of supply and demand for those commodities and the derivatives being traded. There is a lot of free information available from commodity exchanges and trade organizations. Government agencies provide commodity data for free.
In the energy markets, API and EIA (American Petroleum Institute and Energy Information Administration) are excellent sources of information. In the grain, soft commodities, and animal protein markets, the USDA releases weekly and monthly reports that contain invaluable data and analyses.
Understanding commodities will require particular attention to supply and demand. It will also be helpful to learn how to research changes in supply and demand for various commodities. For example, learning how to read and understand the weekly crude oil inventory report published by the U.S. government’s Energy Information Administration would be a good place to start if you want to trade oil futures.
Markets
Futures and options in commodities are laden with risks. There is a massive amount of leverage in these instruments. While there is an opportunity for enormous gains, the chance for profits comes with high risks.
Trading Futures and Margin Calls
Trading futures requires a good faith deposit or margin (a balance that must be maintained – maintenance margin). Commodities are a market with significant volatility. Margin calls may require additional capital – if the value of your investments drops significantly, your broker may initiate a margin call.
A margin call occurs when your broker asks you to add capital to your account because values have dropped below the minimum required for the fair balance you must maintain.
A trader who remains at this level of trading is “trading on margin,” which presents a serious risk and cost of trading. If you do not have the capital to support financial setbacks, you may need to borrow more money each time you lose money. Many traders lose huge amounts of money in margin trading.
Conclusion
You need to exercise caution in the commodity markets, do your homework, and handle these volatile instruments carefully and judiciously. While fortunes can come from trading commodities, the opportunity for losses is equally great.
Online trading has increased the speed and efficiency of execution. Remember to treat online trading as a business – with a plan, discipline, and precision. Mistakes can be extremely costly, so try to keep your trading to a minimum.
The most successful traders are masters of efficiency. Mastering online trading requires a level of expertise that comes from hard work and study. Make sure to utilize all the information available to you. Platforms want you to succeed because successful customers make them successful too.
Finally, since all commodity futures trading relies on leverage and requires the use of margin, you should thoroughly research and seek instruction on the rules and effects of margin futures trading. You must clearly understand how much money you could lose in that environment. You should also research how to minimize the risk of loss while trading and spend many hours practicing and honing your skills before putting any money at stake in this area.
Frequently Asked Questions (FAQs)
How can you start trading commodities if you have a small amount?
Paper trade with a demo account that costs you not a single cent, teaching you valuable trading skills. If you want to use some money, but your funds are limited, you might consider sticking to ETFs (Exchange-Traded Funds), as trading ETFs typically comes with lower fees than trading options and futures. ETFs may also allow for fractional trading. However, if you want to actively day trade, futures are the only option until you have the $25,000 needed to meet the day trader pattern restrictions.
Why is insider trading allowed with commodities?
It is important to distinguish between insider trading and trading fraud. In commodities, as in stocks, individuals involved in an industry are allowed to trade securities related to that industry. Many insiders in the industry use futures to hedge fundamental business risks and keep the cost of raw materials consistent. An airline may use futures to lock in fuel prices. However, insiders trading commodities with non-public information or engaging in non-competitive deals, or participating in any form of fraud, may face severe legal consequences. In 2021, for example, a grand jury in Texas indicted a natural gas trader on multiple counts of commodities fraud – each carrying a potential prison sentence of up to 25 years.
Source:
https://www.thebalancemoney.com/how-to-start-trading-commodities-online-809250
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