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Although most investors are only familiar with trading stocks, such as stocks or mutual funds, or investing in debt, such as bonds, commodity trading tends to be ignored even though it has many advantages over other types of investment instruments. Let’s start by defining what a ‘commodity’ is in the first place. Commodities can come in many forms. The most commonly traded commodities include lean hogs, live cattle, oats, wheat, metals, and even currency.

One of the attractions of commodity trading is the potential for huge profits in a remarkably short period of time. However, most consider commodity trading to be extremely risky, as most investors tend to lose money. However, by doing your due diligence and determining whether the commodity you are interested in is undervalued or overvalued, for example, if you want to go long or short, respectively, you can minimize the risk involved in trading commodities. It can also help to have an experienced commodity trader by your side to guide you.

When you trade commodity futures, you’re not actually buying or owning anything, unlike other types of investments, such as stocks or bonds. You are simply speculating on where the price of a given product will go. If, after doing your research, you think the price of coffee is going to go up, you would buy futures contracts or go long. On the other hand, if you were under the impression that the price of sugar was going to go down, then you would either sell futures contracts or go short.

As mentioned above, you can also buy futures on currencies or market indices, as well as buy or sell futures on commodities such as cattle and hogs. One advantage of trading futures on market indices is that you don’t need to invest a lot of money, rather than having to invest a considerable amount of capital if you were to buy individual stocks. Let’s illustrate with the following, a $10,000 futures contract on the Nasdaq is equivalent to about $200,000 worth of stocks. Say you expect the market to go up shortly, you could buy many of the stocks that are part of the Nasdaq stock index (the herd mentality) or you could buy a Nasdaq futures contract. Suppose you invested $200,000 in stocks on the Nasdaq, and if the index had gone up, you would have made a profit of, say, $25,000. However, if you instead bought a $10,000 futures contract simultaneously, instead of investing $200,000, you would have earned the same $25,000, investing with much less capital in the first place.

One downside to commodity trading is that it is usually done on margin to take advantage of your investment, so a small drop in price could cost you your entire investment. That is why one must perform their due diligence and decide for themselves whether a certain future contract will be a prudent investment. Although commodity trading can be fun, though not without risk, it offers investors another way to diversify their investment portfolios.

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