The agreement to buy or sell a predefined quantity of a commodity at a set price on a future date is known as a commodity futures contract. Commodity futures can be used to speculate on the direction of the underlying asset’s movement or to hedge or protect an investment position.
How Do Commodity Futures Work?
By the time of expiry, the majority of commodities futures contracts are closed off or netted. Cash settlement applies to the price differential between the opening deal and the closing trade. Typically, one uses commodity futures to open a trade in the underlying asset. Typical asset types include:
- Silver
- Wheat
- Gold
- Natural Gas
- Crude Oil
- Corn
These are contracts referred to by the name of the month in which they expire. For example, a contract that ends in September would be referred to as a September futures contract. There may be considerable price volatility or swings for some commodities. As a result, there’s a chance for both significant gains and losses.
Objective of Commodity Futures
Protecting the price of a commodity is one reason to invest in the futures market. Businesses may lock in the pricing of the commodities they sell or use for manufacturing by using futures.
Hedging is done to protect against losses from possibly negative price changes rather than to speculate. A lot of hedgers use or produce the futures contract’s underlying asset. Manufacturers, cattle breeders, farmers, and oil producers are a few examples. The price of raw materials is accurately determined by commodities futures since they are traded on an open market. They also forecast the commodity’s future value. Prices are set by traders and market experts. Every day of the week, they research their specific commodities. Forecasts take into account the news and information of each day.
Occasionally, commodity futures may reflect the mood of the market. Speculators drive up prices because they believe there will be scarcity in a crisis. Bidding wars break out when other merchants discover that the price of a commodity is skyrocketing. This causes the price to increase even further. However, the principles of the supply and demand chain remain the same. Prices will return to normal after the crisis has passed.
Benefits of Commodity Futures
There are several advantages of commodity futures which make them one of the best options for trading. The following are some benefits of trading futures on commodities.
Trading these futures leads to price discovery. Liquidity ensures that the right prices are supplied and prices are transparent. It is simple to compare prices in various global markets because these contracts are controlled.
Producers, dealers, and end users may eliminate uncertainty by hedging against price fluctuations with these futures. Trading these futures benefits you by facilitating diversification of holdings. For example, gold prices move against the price of many other assets. So, gold futures may be used to hedge bets and protect portfolios.
Strategies for Trading Commodity Futures
Let’s now look at some useful strategies to trade commodity futures.
- Trend Following: This method entails spotting and capitalising on current market trends. When the trend is rising, you can buy. When it is falling, you can sell. Following trends may be an easy approach to take advantage of potential profits.
- Range Trading: When trading in markets that are restricted to a certain range, traders try to purchase close to support levels and sell close to resistance levels. Markets frequently have phases of consolidation, which provide chances for profit within predetermined price ranges.
- Breakout Trading: Using this method, a trade is placed when the price breaks above or below a key level of resistance or support. Breakouts might indicate the start of a new trend, which traders try to ride along with.
- Mean Reversion: Traders using this strategy think that prices will eventually return to their historical average. They sell when prices are above average and purchase when they are below. Markets frequently follow a mean (or average). So, departures from the mean might offer trading opportunities.
- Momentum Trading: Traders that employ this strategy concentrate on stocks that have performed well lately in the hopes that the trend will hold. As prices continue in the same direction, traders try to profit on the momentum that may continue.
- Divergence Trading: Using this method, one may predict a possible trend reversal by spotting differences between a commodity’s price and an appropriate indicator. Divergences might be a sign of changes in the mood of the market, opening doors for calculated entries.
Conclusion
Commodity futures trading offers an array of opportunities. Since most commodities will remain in demand for many years, there are plenty of possibilities to make profits. Typically, major institutional players possessing significant experience control the majority of these futures markets. However, there’s no reason why retail investors can’t profit. You can start trading on a good platform that facilitates commodity futures trading. Go with platforms like Kotak Securities, which is the best stock market apps. It offers several trading tools and Indicators to conveniently trade in the derivatives market. So, you can trade commodity futures and take advantage of this unique financial instrument.
