Commodity futures trading is an agreement between two parties to buy or sell a commodity at a set price on a future date. Futures trading in Australia can offer investors and traders several benefits, including hedging against price movements, the potential for profit in both rising and falling markets, and increased liquidity.
Hedging against price movements
When prices for a commodity rise, the cost of producing that commodity also rises. It can consume your profits and, in some cases, cause losses. By hedging with commodity futures, producers can lock in a set price for their commodity, protecting themselves from rising costs and ensuring a stable income.
Potential for profit in both rising and falling markets
With most investments, you can only make money when the market increases. But you can make money with commodity futures even when prices are falling because you can sell your contract any time before it expires – and as long as the price you sell at is higher than the price you paid, you will make a profit.
Since commodity futures are traded on exchanges, someone is always willing to buy or sell, which means you can get in and out of a position quickly and easily. And if you need to raise cash, you can do so by selling your futures contract.
Ability to take physical delivery
Suppose you hold a commodity futures contract until it expires. In that case, you have the choice to take physical delivery of the commodity, which means that you can avoid the costs and hassle of storing the commodity yourself.
Access to a broader range of markets
Commodity futures give you access to markets you might not otherwise be able to trade in. For instance, if you want to invest in gold but don’t want to buy and store physical bullion, you can trade gold futures instead.
Including commodity futures in your portfolio can diversify your holdings and reduce your overall risk because commodities tend to move differently than stocks and other financial assets.
Commodity futures contracts come in various sizes and can be customised to meet your needs. For example, you can choose the type of commodity, the delivery date, and the contract size that best suits your investment goals.
Because futures contracts are leveraged instruments, you can control a significant position with relatively small capital. It gives you the potential to amplify your gains – but it also magnifies your losses, so you need to be careful.
Efficient price discovery
The futures markets are the most efficient way to discover commodity prices because futures contracts are standardised and traded on exchanges, providing greater transparency and liquidity.
Reduced transaction costs
Transaction costs are typically lower in the futures markets than in other markets because there is more competition among participants, and technology has further reduced costs.
The futures markets never close, so you can trade commodity futures 24 hours a day, which makes it easy to take advantage of opportunities as they arise, no matter what time.
Potential tax advantages
In some cases, you may realise tax advantages by trading commodity futures; for example, holding a futures contract until expiration may be eligible for special tax treatment on your gains.
Risks of trading commodity futures
Here are some risks of trading commodity futures.
The prices of commodities can be volatile, which means they can rise and fall quickly, making it difficult to predict what will happen in the market and leading to losses if you’re not careful.
You contract with a second party when you trade commodity futures, which may default on the contract, resulting in losses.
The prices of commodity futures can be manipulated by large traders, which can lead to losses for other participants in the market.
If the price of your commodity futures contract falls below a certain level, you may be required to post an additional margin. You may lose your position if you don’t have the funds to meet a margin call.