What Makes Trading Commodities Futures Risky?

Commodities futures trading is considered a mighty risky enterprise by most folks. And they are right if you examine the way most traders trade. Most folks trade in a way that almost insures losses. But it is the traders and their flawed trading techniques that are at fault, not commodity trading as a possible money making business venture.

The price movement of commodities as an asset class is really not unlike that of stocks. That is if you measure the yearly range of commodities from the high to low price you will find the percentage of change to be not much different than if you compare stocks in the same way.

What makes commodities so much more interesting and risky to trade compared to stocks is the amount of leverage available to the trader. In a stock margin account you can usually trade at 50% margin. That is for every dollar you have in your margin account you can trade another dollar worth of stocks. So if you have $10,000 in you margin account you can trade up to $20,000 of stocks.

Let's compare that to what you can do in a commodities trading account. In commodities a 5% margin requirement is fairly standard. So in a commodities trading account you can trade 20 times the amount of funds that you have in your account. That's quite a difference. Your $10,000 can now serve as margin for up to $200,000 worth of commodity positions.

This means that you can make or lose money much more quickly in a commodity trading account than you normally would in the stock market. This can be a good thing or a bad thing depending upon how good of a trader you are.

The important thing to realize is that you are the one that controls the amount of margin that you employ in your trading account. Just because you are extended all of the powerful leverage by your brokerage firm doesn't mean that you have to use it. The way to decrease leverage is easy.

Just keep more backup capital in your trading account. Instead of trading $200,000 of commodities with $10,000 in your account and trading at 20 to one leverage perhaps you should keep $25,000 in the account and trade at eight to one leverage instead. Or keep $50,000 in the account and trade at four to one. Or if you want to trade at the same ratio as you would in your stock trading account keep $100,000 on hand and trade at two to one. You are the one in control.

But what if all you have is $10,000 in risk capital but still want to give commodity trading a go? First of all do your homework before starting to trade with real money. Many online firms will let you open pratice accounts. While it's not the same psychologically as trading your own real money it does give you a risk free way to get used to the trading procudures and to try out your trading system.

You can also trade risk by choosing to trade less volatile commodities. For example, corn would normally not have nearly the volatility of silver. Soybeans will usually be more frisky than wheat.

The very best way to control risk , however, is to be very careful with your trade entry points. And to not always be in the market. Being in cash is often the best position that you can possiblity have. But, oh so hard to do for so many traders to do. Most traders overtrade. That's good for your commodity broker but bad for you.

So what do I mean by being careful with your trade entry points? Put the odds of making winning trades in your favor by always trading with the major trend and put positions on only on reactions within the trend. For example, if gold is in a major up trend, as it is as of this writing, August 2006, then buy gold only when it corrects and pulls back from recent highs.

Trading with the major trend is by far the best way to have a high percentage of winning trades. By doing that and by having an adequate amount of ready risk capital on hand you greatly reduce risk and can make small mistakes with your entry point and still make money on the trade as the major trend kicks in.

But what if you don't know the major trend? That's an easy one. Don't trade.

Of course, there are other factors that determine risk in commodities futures trading. But it is the leverage factor improperly applied that packs the power to give the careless trader a fast killer blow. And it is trading against the major trend that will give you a for sure poor winning trade percentage.

So in the end what is it that makes trading commodities so risky for so many traders? That's also an easy one. It's the traders own lack of discipline and desire to always be in the market. But you can control that, right?