commodity futures can be very risky

When most people think of investing they picture an individual purchasing a share of stock from a company. While this is a very common form of investing, it is important to realize that it is not the only form. In reality, there are a wide variety of options from which to choose. Each choice comes with its own set of rules and its own level of risk. One of the riskier opportunities available today is trading commodity futures.

A commodity is a crop, a mineral, a metal, or virtually anything you can get out of the ground. In order to understand how commodities are traded today it is helpful to understand a bit of history. In 19th century America, it became common for dealers to make sales arrangements with the farmers in regard to future shipments of produce. The dealers would agree to pay a certain price and in return the farmers would agree to deliver a given amount of produce on a given date. Once an agreement was reached a contract would be written. If the dealer decided he did not want to purchase the crop then he could sell the contract to another dealer. Likewise, the farmer could choose to sell the contract to another farmer. Additionally, the value of the contract would rise and fall depending on changing crop related conditions.

In modern times, this system is generally used for 1 of 2 distinct purposes; hedging a purchase or speculative investing. Hedging a purchase is simply an attempt by a buyer to offset the risk of changing commodity prices. For example if a bakery needs to purchase a large amount of wheat he may choose to purchase a wheat futures contract. If the price of wheat goes up due to market conditions then the bakery will have to pay more for this commodity. However, at this point it can sell the wheat futures at a profit to cover the additional cost. The purpose of speculative investors is simply to make money. The object is to buy a futures contract and then to sell it when the value increases. A contract states that the buyer is obligated to pay a specified amount of money in exchange for the commodity upon a certain date. However, speculative investors will sell the contracts before the expiration date occurs. Money is made or lost depending on fluctuations in value as market conditions change.

The main advantage for speculative trading in commodity futures is that an investor can typically make a greater amount of money in a shorter span of time than other forms of investments. This is possible due to the rapid movement of pricing. However, for the same reasons it is also possible to loose more money in a shorter amount of time. Generally, this is not an investment venue suited for the casual investor.