Trading Commodities - Potential Profit And Dangers Explained
Trading Commodities Exposes You To Abundant Wealth And Similar Risk
Trading commodities can be exceptionally profitable. However, it can be an extremely dangerous game.
Used as originally intended, the Commodities Market adds to the accuracy of Business projections of their income and expenses.
Outright speculation by major players, though, have contributed to it’s volatility and its danger.
To explain how it can be extraordinarily profitable and add stability to business projections, lets look at an example.
Lets use a company that uses oil in its production or operating process.
Noted are a few Facts about oil when trading commodities.
- On the Commodities Market
- 1 contract on crude oil (Light Sweet Crude) is 1,000 barrels (bbl)
- Crude Oil is priced in US dollars
- It is traded on the New York Mercantile Exchange
- Crude oil daily limit move up or down is $10. That means if it moves up by $10, you cannot continue to buy it but you can sell it.
Similarly, if it moves down by $10, you can not continue to sell but you can buy.
- There can be wild swings. As we have seen recently, oil fluctuated between just above $149 per barrel and near $30 per barrel in a few short months - an amazing $110 plus swing.
Lets continue with our example to show how it is profitable and adds accuracy to business projections.
When oil was at $149, a company that was in the oil production industry, lets say Exxon, could have sold oil 1 year, 2yrs, 3years or however far out in time that the contracts were been bought and sold for.
They would thereby lock in the prices they sold for - for instance $149 - over those periods.
Therefore, when Exxon projected its income for those future time periods, it knew exactly what the price would be for those periods.
It would be the price they received when they sold the futures contracts.
If the price went above $149 when those dates came around, then the opportunity cost would have been greater had it not sold futures.
At $149, though, Exxon still would have made a huge profit because the cost of their production would be much lower than what they sold for.
They just would not have made as much as if they had not sold the futures.
On the other hand, if oil prices dropped, they would have already locked in the higher prices and would be congratulating themselves for at least being astute if not pure geniuses.
The fact was that oil prices not only dropped, they plunged earthward during the recession of 2008 - 2009 with such dizzying speed and velocity to give anyone who was long crude oil palpitations and cardiac problems.
Not to mention the havoc it raked on their financial accounts!
Also as oil prices dropped close to $30, in our example, Exxon would be in a favorable position in more ways than one.
They could actually do nothing. Then on the delivery dates of the contract, deliver oil for $149 per barrel regardless of what the spot price was at that time.
If Exxon believed that price had fallen far too low and was likely to move back up, they could even have bought back all or part of the contracts they sold and profited handsomely from these windfall profits.
Contributing to the volatility of prices when trading commodities is the fact that the Commodities Market is outrageously leveraged.
When trading commodities, You are only required put up a small fraction of the cost (a margin) of the contract to purchase that contract. However, you assume the full gain or loss on the entire contract.
For producers and large consumers of oil, the Commodities Market provides a great way for them to hedge against their respective interests.
This makes the business projections of their income and expenses more predictable.
However, the commodities market is a place of immense speculation by other huge players who have nothing to do with the product, can’t take or make deliveries and must get in and out before expiration dates.
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