How trading commodities can grow your portfolio

How does commodity trading work and what types are there?

Commodities are among the oldest markets available to investors, having been traded for hundreds of years. Despite their age, commodities present a unique opportunity for investors as they tend to be less correlated to other asset classes. This means that stocks and bonds often move in the same direction at the same time, while commodities usually move independently of them.

What are commodities?

In most cases, raw materials are agricultural products, metals or minerals that have not yet been processed into a finished product. Very long-term trading in commodities is very different from short-term trading in commodities. Short-term commodity trading refers to the buying and selling of commodities in the futures market, which is actually a form of financial speculation. Long-term commodity trading means investing in companies that own and/or operate facilities that produce commodities such as plants, metals, and minerals. These are two very different investments. They require different skills and different financial strategies. And they also have different risk profiles.

Invest in commodities for diversification

The number one reason to invest in commodities is that they add additional diversification to a portfolio. Commodities move in cycles with rising and falling prices over the long term. When they fall, they tend to fall less than stocks, and when they rise, they tend to rise less than stocks.

Because they are less correlated to stocks, commodities offer additional diversification to a portfolio. This additional diversification can help reduce portfolio risk. So for long-term investors, commodities can be a very useful investment.

However, there is no guarantee that commodity prices will not fall at the same time as stock prices. Sometimes they do, sometimes they don't. It is crucial to realize that commodities and stocks follow their own cycles.

Invest in commodity ETFs

Exchange traded funds (ETFs) are a great way to invest in commodities. They offer diversification and, like stocks, can be purchased through a brokerage account. The largest ETFs in the commodity space are the iShares Core S&P Commodity ETF (Ticker: CRB) and the PowerShares DB Gold Double Long ETF (DGP). Note that commodity ETFs are not suitable for long-term investments as they are extremely volatile. The results are unpredictable in the long term. You should only invest in an ETF with a very short-term perspective. Note that commodity ETFs are more often highly leveraged, which means they make very large gains if the commodity's value rises. However, they also make huge losses when the value of the commodity falls. So they are not suitable for long-term investments.

Invest in commodity futures

Commodity futures trading allows you to make a profit by buying a contract that calls for the sale of a commodity at a specific price in the future. If the price of a commodity is expected to increase, you can buy a contract to sell it at a specific price in the future. You make a profit when the actual price of the goods is higher than the contract price.

Commodity futures contracts may be bought and sold through a broker. The margin requirements are similar to those for stocks. You can invest in commodity futures through an account with a broker or commodity trading advisor. The minimum account balance is high and commodity futures accounts are very risky. If you decide to use this strategy, you should do some research about the type of account and the risk involved before investing.

Investing in commodity mutual funds

Commodity funds are a great way to invest in commodities when you can't afford the high minimums required to trade commodity futures. Commodity mutual funds typically invest in futures or other derivative contracts. As such, they are very risky. You should only invest in commodity funds if you cannot raise a high minimum amount. Like ETFs on commodities, commodities funds are not suitable for long-term investments as they tend to be volatile. The results are unpredictable in the long term.

Final words: Is it worth investing in commodities?

As we have seen, commodities are a great way to diversify your portfolio. Note, however, that commodities are highly volatile and are only suitable for short-term trading. If you want to invest for the long term, commodities are generally not suitable as they are too risky and unpredictable. Commodities are therefore generally not suitable for long-term investors.

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