Hobofinance

Three reasons I trade commodities futures (options) instead of stocks:

1. There are far fewer commodities than stocks.
The simplicity of researching and finding a market with bullish price potential is much easier when you have to sort through only 20 commodities rather than 5,000 stocks. And to simplify further, commodities belong to groups where each member behaves in a similar fashion. Gold and silver (metals) will tend to rise and fall in relative concert, as will wheat and corn (agriculturals). In the last year we’ve seen wheat and soybean prices rise in tandem and make all time highs. Only so much land can be allocated to a certain crop and wheat, soybeans, corn, and cotton compete for that same land based on their perceived profitability. If the price of one rises rapidly, then farmers raising other competitive crops will switch to the more profitable one. This creates a deficit in supply of the crop that lost its land and in turn will result in higher prices to compensate. If you missed the historical run up in soybean and wheat prices, it isn’t too late to profit from their ascension, because the current values of wheat and soybeans is enough to draw available arable land away from corn and cotton, creating a shortage and driving prices higher over the long run.

2. Commodities Futures offer greater leverage than stocks.
We have the ability to purchase commodities futures on margin, which means I can control a full futures contract with a small down payment, perhaps 5%. There are some brokerage firms that will allow you to trade stocks on margin, perhaps 50%, though not so common these days. This is a difference that turns a lot of people off at first because it opens the door for you to risk more than 100% of any one trade if it moves against you. At present the price of Crude oil is about $125 per barrel. There are 1,000 barrels of crude oil in one futures contract. $125 X 1,000 barrels of crude oil means a crude oil futures contract is worth $125,000. If we had to pay that much money to purchase a contract, most of us would have to stay out of the game. Fortunately for less than 7% down payment (margin) I can control the whole contract. Let’s say for the sake of simplicity that the current margin is $5,000 dollars. If crude rises only 5% from $125 to $131 per barrel, then I double my money ($131,000-$125,000= your profit of $6,000). A move like this can happen in one day and in some cases a matter of minutes. The need for caution lies in the fact that if crude prices fall 5% to $119 per barrel, not only did you loose your entire margin ($5,000), but you’ll have to pay an additional $1,000 dollars. This is not a risk to be taken lightly, but for someone willing to do the work and research, it can offer the fastest path to wealth. For a safer version, try futures options, not unlike stock options, where your risk is limited to 100% of your risk per trade.

3. Commodities are more transparent that stocks.
Commodities Futures can be analyzed in terms of real world supply and demand. No matter how well a stock is analyzed, its future growth is subject to forces that cannot always be analyzed. As investors we are looking only at numbers, we have no idea what’s happening within the walls of those companies. Remember Enron. Commodities don’t rise and fall based on the productivity of, in many cases, thousands or hundreds of thousands of employees and managers. Commodities are swayed by one force, the indelible law of supply and demand. If there is not enough crude oil to meet world demand, than the price of oil rises. It is that simple. Timing the market, however, is difficult, but I see that as the trick for all forms of speculation, and not exclusive to commodities futures. What makes timing somewhat more important in commodities trading however is the added leverage, which can work against you as quickly as it can work for you.