There are a few other options for trading commodities that you should also learn about. While these aren’t as simple as stocks or futures trading, their complexity gives them certain strengths – and weaknesses – the simple trading methods don’t have!
Exchange-traded funds & notes
These are marketable securities that trade like stocks on the stock exchange. They track to commodities – as well as other items, and the price of them raise or lower with the value of the commodity and the amount of people buying and selling the funds & notes. While these don’t track 1:1 with the value of the commodity, they are a way to trade on the commodities with less of a risk of losing your investment if the commodity price lowers dramatically.
Exchange-traded notes differ from funds in the fact that the notes are linked to the issuer’s credit rating. So if the issuer’s credit rating drops, the value of the note will do so too.
It’s important to note that not all commodities allow ETFs or ETNs to be linked to them, also between countries, the value and rules associated with these change, so normally they are only traded domestically.
Mutual Funds and Index Funds
Mutual funds are a group or pool of funds from many different investors in order to invest in bonds, stocks and similar items. Index funds are built for the same purpose, but to trade on specific indexes, they are created with certain standards or rules and parameters.
These funds can’t invest into commodities themselves, but they can invest into stocks in companies that deal with commodities, such as agricultural or mining companies. Just as with trading in stocks directly, these funds aren’t just affected by the price changes of the commodities, but also company-specific and industrial issues as well as stock market changes.
As these are a way of providing those with a relatively low entry cost into stock market trading, they normally come with a high fee in order to make it worth the time and business of the trader.
These are investments into the futures market made by a group of traders called Commodity Pool Operators. These operators are only allowed to trade with futures once they have been subject to an FBI background check and even then, only if they follow very specific rules on trading. These managed futures are a pool of funds from various investors, but all investors must put in the same amount of money.
As these pools tend to be very well looked after and diversified to a great extent, they usually come with little risk, but at the same time, not as great an upside as direct trading.
You can also access information on how the Commodity Pool Operator’s investments have done previously due to them having to produce public performance documents periodically.
While these are a safe option, you don’t have any control over your funds and the amount of profit you can make in changing market conditions isn’t as great as directly managed futures or stocks.
So which trading vehicle you choose to use does depend greatly on not just the amount of money you have to put in to the investment, but your aversion to risk and whether your business deals directly with a commodity.
If you are thinking of making your first venture into commodity trading, we would recommend Managed Futures as these are the safest option, while also not requiring you to be checking it consistently.
If you own a business that produces or deals with commodities, futures trading is your best investment as this can lower the risk to your business through betting on the downside, which lowers your financial cost if a commodity price changes.
If you are an experienced trader and wish to get involved in commodities for the large profit available at a great risk, then we would recommend stock trading on the commodities companies as your profit can not only benefit from a commodity price changing, but also the company’s or industry’s situation changing.