Thursday, September 13, 2007

Trading Futures: The Wise Are Wary

No doubt youve seen the late night commercials extolling the virtues of trading commodity futures. People have made millions with small investments almost overnight. Read the fine print: Results are not typical. Trading commodity futures can result in enormous profits but it is a tricky business. Only those with money they can afford to lose should consider dallying in this market. That said, trading futures is a fascinating and high profit endeavor which those with a high risk tolerance may find to their liking.

The term futures actually refers to a futures contract. Buying a future means entering into a contract to buy or sell a commodity for a specific price at a specified time in the future.

Futures emanated from the 1800s when farmers began selling their crops before they had actually been brought to market. A future was essentially just an agreement between the farmer and the buyer as to the price that would be paid when the crop came in. Obviously, depending upon weather conditions while the crop was in the field the value of the crop might go up or down. If a hail storm destroyed most of a certain crop then the value of the future might go up because there would be less of the commodity to go around. On the other hand, a bumper crop might cause the value of the future to fall. Over time people who owned these agreements or contracts began to sell them prior to the harvesting of the crop. Thus, a market in futures was born.

The modern futures market has become much more complex and deals not just in crops but in all sorts of sorts of precious metals as well as crude oil, gasoline and even electricity. Futures are sold throughout the day on a variety of exchanges including the Chicago Mercantile Exchange (CME) and the New York Mercantile Exchange (NYMEX). Trading commodity futures would be complicated even if only actual farmers and those interested in using their crops were involved. Todays commodity markets, however, encompass an enormous variety of traders.

Many large institutions trade options and speculators are also rampant. Speculators are in the commodities market only to make money and often buy and hold positions for just hours or even minutes. They trade on scraps of information and hints gleaned from the news. Sometimes they make trades on the basis of volume alone. Both institutions and speculators also hedge options which simply means they try to protect their positions by hedging their bets. Hedging in the simplest terms refers to the practice of taking a futures position that is in opposition to a position taken in the stock market. By doing this a person is covering himself/herself no matter which way the market moves. In truth, hedging can result in enormous losses. Hedging is only once of many devices which are used in trading commodity futures. So called futures derivatives can become so complicated that not even traders with years of experience are entirely sure what is being sold.

If you are considering trading commodity futures it is imperative that you read and study extensively before making any investment. After a period of study you should investigate the commodity options brokerage houses. Commodities cannot be traded on the exchanges directly by individuals. They have to be traded through people and firms who are registered with the Commodities Futures Trading Commission. Carefully read through the disclosure information which is provided by the brokerages you are considering.

Once you have decided to trade commodity futures, think again. Part of the reason futures trading can be so profitable is because trading is done with a leverage account. Leverage means you are only putting up a portion of the money and borrowing the rest on margin. If the futures go up your account pays the leverage costs out of the profits. If the futures you have bought go down you will have to pay the difference out of your own pocket. When futures fall precipitously you may be called upon to pay the money you owe immediately sometimes within an hour. It bears repeating that trading commodity futures is only for those who have capital they can afford to risk and lose.

Bear the following in mind.

Do not deal with anyone who will not provide disclosure documents. Do not allow anyone to pressure you or intimidate you into opening account. Do not use money you cannot afford to use to trade commodity futures. Do not borrow money to trade commodity futures. Do not be lured into opening an account by promises of quick, easy profits.

Trading commodity futures can be lucrative and exciting. Conversely, it can cause the loss of every penny invested and liability for any money borrowed on margin. Therefore, for anyone considering trading commodity futures the motto is truly, Buyer beware.

Christopher M. Luck has an extensive background in working exclusively with the commodity trading and is now offering his free trading tips to the public. If you are at all interested in Christopher's trading advice, tips, or secrets, you can visit his commodity blog