September 21, 2021
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Finance

Downsides and Risks of Commodity Trading

Commodity trading is one of the most lucrative ventures in the financial markets.

This type of trading lets you benefit from the prices and movements of commodities like gold, oil, and base metals.

However, it’s also a very complicated business. So, before you start trading commodities, make sure you’re aware of the following downsides.

Speed

There was a time when commodities were traded in a pit. That meant that that for you to have your order executed, you need to contact your broker who will in turn transmit your order into the pit trader.

The pit trader then executes the transactions and will inform your broker who will pass the confirmation to you.

Because of the time lag, the risks of slippage occurrence were off the roofs.

Fortunately, these days, traders can use derivatives like futures contracts to lock in prices and therefore preventing time lags from affecting their profitability.

Leverage

Since there are low margin requirements, the trader is often tempted to commit poor money management.

And poor money management usually leads to unnecessary taking on of risks. In this case, you may believe that your chances of winning trades are great. However, your chances of incurring huge losses become even greater.

High Levels of Risks

As we’ve mentioned, commodity trading is very much not for beginners, as this is a very complicated market.

That means you have to be very careful when making trades in this market. It’s really possible to be careful and try to risk only a few dollars per trade. However, many traders are too impatient and often go try and make it big by starting big.

Geopolitics

Another inherent risk to trading commodities is that the most important and profitable commodities are located in different continents. Therefore, the jurisdiction over such assets are in sovereign governments, international corporations, and many other entities.

As a result, contradictions and international conflicts among these entities are quite common. For instance, a country that hosts commodities can kick out a foreign company involved in the production and distribution of then natural resource.

Speculation

The commodities market is different from other financial markets. At the same time, it also shares a lot of similarities to these markets.

Therefore, you can also find traders that make short-term profits by speculating whether the price of a security will go up or down.

And because these speculators are primarily focused on making short-term profits, they have the tendency to move the market in different directions.

Although these speculators serve up the much-needed market liquidity, they also propel the volatility to higher levels.

Corporate Governance

There is also the risks of plain and simple fraud. Even though the Commodity Futures Trading Commission (CFTC) and other regulatory authorities are doing their job to protect investors from fraudulent entities, there is always the risk of falling victim to fraud.

In order to prevent this, you must be vigilant about your investments. If you are going to use the services of a firm, make sure that you thoroughly research it before you start handing out your money.