Leveraging Your Investments for the Best Long-Term Results

June 30, 2009 by  
Filed under Commodities Trading

Futures contracts are the most common form of trading in the commodities market. A certain percentage of the price, called a margin, is paid by the investor to lay claim to a specific contract that expires on a future date.

So, why are futures so popular in the world of commodity trading? Well, this is mainly because investing in the actual commodity will require physically possessing it and storing it, and finding a buyer to purchase it. Futures allow for paper investments in the same goods without these requirements, but also bring added risk to your portfolio.

This is where leverage comes in to play. Leverage is important for any investor, and some may require more than others. Futures contracts can be bought with only a percentage of the actual sale price, but allow for you to reap all of the profits. This allows you to use the bulk of available funds for alternate uses that are more important in the meantime.

As an investor, you can control the contract for a specific unit of a good with only 5% required of the price of the contract. The 5% is known as the ‘margin’, and will always depend on volatility, new regulations and other market factors.

For example, gold could be trading at $550 per Troy ounce (the standard unit of gold) on the Chicago Board of Trade. Your margin, or 5% of this amount, would total $27.50. If you want to purchase a future contract for 100 ounces of this gold, you may do so with only $2,750. In effect, you will own and control the entire $55,000 of gold via your commodity broker loaning you the remaining value of the units.

If the price of gold rises to $560 prior to your contract’s expiration date, you have experienced a $5 per ounce net return. This means that you profited $500 from your 100 ounces of gold, and earned a $500/$2750 = 18% return – not bad for a day’s work!

However, don’t forget that commodity prices experience new highs and lows on a daily basis at times, and this profit can just as easily become a loss that is devastating. Much research is required before participation in commodity trading, and you should understand the concepts well before calling your commodity broker to bet the bank on wheat this fall – make sure you understand exactly what it is you’re doing.

Futures contracts are so popular because they allow investors to profit from increasing prices of goods over time, according to their predictions. This type of commodity trading never requires you to take actual possession of the product, but you still profit from the sale of it.

These contracts affect virtually every area of consumer spending on a daily basis, and can easily lead to consistent short-term investment results with enough practice and patience. Leveraging your all-important cash for long-term investments or real product purchases allows you to still engage in the profitability of the market, but without needing to part with all of your cash in the meantime.

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