Risks and Benefits in Investing in Commodities

Pork bellies, soybeans and coffee: these are just some of the many different products that are freely traded on the commodities market. There are substantial amounts of money that can be made in commodities markets; leverage, greater risk and a volatile market all help commodities investors to make large profits in short periods of time. The commodities market is far different from the stock market, as commodities can move based on rainfall, the costs for fertilizers, and the actions of large commodities traders. There are simply many more factors that go into the price for commodities than that of the stock market. With so many variables and facts to consider, the commodities market is obscenely profitable for those who understand it best.

Volatile Swings

Commodities are known for huge intraday swings based upon various world events. Consider the largest commodities market, the oil market, where geopolitical events often urge a 10% gain in oil prices. These types of market dynamics make trading commodities best for short term trading. Day traders disproportionally move to commodities market for high price activity and the potential for huge leveraged profits.

Commodities are an Inflation Hedge

The largest benefit that commodities bring to the table is the inflation hedge. When money supply grows rapidly, the commodities market is always the first market to show it. Moderate inflation was able to push the price of oil from $70 to $140 per barrel, even with inflation of money supply around 10% per year. Gold and silver also rose greatly on rather small inflation statistics, as investors move to commodities when the value of a currency drop. Commodities, unlike cash, are hard assets that will always retain a certain level of value. Oil will always be needed by someone, everyone enjoys their daily dose of coffee in the morning, and beef sustains much of the world's population. Unlike stock, or ownership in a business, your commodities always have some sort of nominal value.

Too Much Leverage Can Risk Your Portfolio

Commodities and futures are generally traded with large amounts of leverage. Intraday buyers and sellers in the commodities market want to multiply the daily moves of the market by using borrowed money. This can be both a benefit and a risk, as profits are multiplied along with losses. Leveraged drawdown eventually hurts a portfolio, where large losses wipe away profits of many trades. Drawdown forces a trader to use greater leverage to produce similar profits after a loss, which can be damaging to the trading psyche.

24 Hour Market

Like currency trading, commodities are a 24 hour a day market. As one market closes for its trading session, the next is set to open to pick the world market of commodities back into business. Trading 24/7 markets is again a benefit and a risk; holding positions overnight means the price will continue to change even while you're sleeping. With the stock market, the short session can be slept off for the next day.  In contrast, with commodities, your portfolio is rising and falling throughout the day. Long term commodities investments are better made in companies that produce or market a commodity, rather than in the commodity itself. 24/7 high volatility trading is far too much for the average investor.