Commodity Market Risk

By | May 21, 2013

CME Gold futures and CME Silver futures had a most volatile move in recent time yesterday.  Precious metals were continued with their fall on monday morning  but staged a miraculous recovery leaving gold with its best gain since June 2012.

Gold which made a low of $1437 make a sharp pullback in evening session and pullback near $1400 odd levels.  CME silver Futures made a 12.5%, retested $ 23 after making a low of $19.7 move in single trading session with volume 82% higher than 100-day average.

So precious metals showing such wild moves,You can’t help but think about risk when you think about trading commodities. Any wrong trade without a strict Stop loss could have wiped you out of market.  I have seen many small traders with capital as low as 50K trade in commodity market and such wild moves wipe them out of market as they just trade on “LUCK”, they have no trading system.

The aura of high risk in commodities is strangely what drives many traders into the commodity markets. Due to wild moves in commodity as described above many traders are attracted to trade in commodities as they think big money is waiting for them . But they will never think from RISK perceptive.

But, is the risk of commodities misunderstood?

The main reason why commodities are considered risky is that commodities are traded in futures contracts and they are highly leveraged. A commodity trader normally only has to put up 5 to 20 percent of the contract in futures margin value to control the commodity investment.

For example, Commodities are highly leveraged instruments and  can have 20 to 1 leverage,  so you just need to have a 5% margin and you are ready to take positions, For example, gold futures trading at mcx are at 27000 per 10 grams . Suppose traders want to take position in 1 KG Gold at MCS Futures he needs only 1.5 Lakhs to trade 1 KG gold position worth 27 lakhs.Gold in general has been moving about Rs 300-500 per day a day, which equates to a 2-5 lakhs  daily move on just a 1.5 lakhs.So one wrong move by Gold and  how quickly you can get into trouble if you don’t respect the leverage.

Silver often moves more than Rs 1000 every trading day. How do you feel about entering a commodity trade with 100000 in margin and realize that position can move for or against you by about 40 percent every day?

That kind of leverage in the hands of an undisciplined trader is the reason so many new commodity traders lose money. It is commonly discussed in the futures industry that anywhere from 80 to 95 percent of traders lose money in commodities. Most of these traders are also new to the markets and have accounts of less than $50,000.

So, the statistics show that commodities can be very risky to the small trader who is not prepared for the leverage. On the other hand, market professionals have been able to show very consistent returns as they trade large pools of money and they are able to control the risk through diversification and thoroughly tested trading strategies. In the end, commodities can be very risky or they can be just another investment that often earns above average returns.

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