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Before you trade commodities you need to understand the risks and the market

by , 26 May 2014

Over the years, commodities have become ever more popular. You can see this trend is the launch of several different commodity-backed exchange traded funds (ETFs). But before you jump in, you need to understand exactly what investing in commodities is all about and the risks involved. Read on to find out what you need to know...

How you can trade commodities

If you want to trade commodities, you have two options open to you:
  1. You can spread trade them; or
  2. You can buy an ETF.
Let’s look at option one first. Spread trading commodities is highly risky, John Stepek in Money Week explains. And it’s certainly not something you should embark on if you’re new to the commodity game.

Looking at option two, you need to know exactly how the pricing of the ETF works before buying. Some ETFs use the futures price and not the spot price. The futures price may not behave the way you’d expect it to.

The main problem of trading in commodities

Investing and trading in commodities is pure speculation. You’re either betting the price will rise or the price will fall.

Unlike shares, which might pay dividends, commodities produce no income. So it’s not a long-term investment option, it’s a bit of a gamble.

And over the long-term most commodities tend to fall in price. This is down to the creation of cheaper substitutes or increased production of the commodity in demand.

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A long-term view of commodities

It’s a good idea to view a direct investment in commodities as a trade, not a long-term position.

For example, if you believe that copper is going to increase in value, buy shares in a company that produces copper. If you think food prices will rise, buy shares in a company that will benefit from that, such as a fertiliser company.

So there you have it, why you need to understand the risks and the market before you trade in commodities.

Before you trade commodities you need to understand the risks and the market
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