Trading Futures or commodities can be very rewarding. At the same time it can be perilous.
The continuation of this series is to help you understand how to participate in this potentially profitable market and at the same time properly manage your risk.
I will eventually show you how using Commodities ETFs (in Part 5) can be a safer way to play in the futures market while properly managing your risk.
Trading Futures allows you to trade commodity contracts and options for brent or crude oil, silver,, currency, copper, corn and other grains, gold metal, indexes and other products.
In the US, Futures Trading Exchanges include the Chicago Mercantile Exchange (CME), Globex and NYMEX. Online brokers facilitate traders to make trades and provide quotes, charts, and software systems .
First though, permit me to explain further some of the dangers of this Volatile and leveraged market.
To do this, let us look at an example.
Again, lets use crude oil as the example. Assume the price is $80 per barrel. In that case, 1 contract of Light Sweet Crude is worth $80,000 (i.e., 1000 barrels x $80 per barrel).
The margin that you will be required to put up to acquire 1 contract is a small fraction of the cost of the overall contract - lets say $5000(margin requirements do fluctuate).
Remember, when trading futures, you assume the full profit or loss of the entire contract even though you only put up a small amount as margin to purchase the entire contract.
Crude oil daily limit move up or down is $10. That means if it moves down by $10, you can not continue to sell it but you can buy it.
Similarly, if it moves up by $10, you can not continue to buy it but you can sell it.
Therefore, if you are long oil and price moved up by $1, for every contract you own, you would make a profit of $1000. (An increase in $1 would make the contract worth $81,000).
When you bought, it was worth $80,000. Your profit is $1,000.
Similarly, if it increases by $5, you gain $5,000; by $10 you gain $10,000 and so forth and so on. As you can see, in a short space of time, you can make hundreds of percent profit if the market moves in your favor.
On the other hand, the market can move against you and often does. If it moves down by $1, for every contract, you lose $1000; if it moves down by $5, you lose $5000; if it moves down by $10, you lose $10,000.
Any of these moves can take place in one day.
Again, lets say that the market moves against you by $10 and you still held your position. It is likely that your broker will issue you a margin call for you to come up with more money to stay in your position.
Never answer a margin call. In fact, you really should have been out on your own before that. However, if you stayed in this long, let this be your final stop loss.
If you fail to answer your margin call, the broker will try to close out your position. She will get you out at the first opportunity. This could be very tricky.
Lets Look At A Worse Case Scenario
In this scenario, the market opens limit down as happens from time to time and stays that way throughout the day. Remember you can’t sell when its limit down.
Suppose it does the same thing same thing the next day and for several days after that.
Your broker is trying to sell to get you out but she can’t. It is therefore conceivable that the first opportunity the broker gets to close you out of your position could be $20, $30, $40 or more down.
The really bad news is that you are responsible for the entire lose. So, say you had acquired 2 contracts.
Also assume that the price per barrel fell by $40 without you being able to get out for 4 days.
You will be responsible for $80,000 ($40,000 for each contract) lose. That would hurt wouldn’t it?
On the other hand, had it gone up by $40, you would be laughing all the way to the bank.
You can see, therefore, why you would want to be exposed to this market but be protected from the dangers of it.
Continue to read - you will see how you can.
By the way, trading futures and trading commodities are one and the same.