The Smart Profits Report: #450
Thursday, August 23, 2007 Futures Commodities: How To Invest In The Volatile Commodities Market
By Lee Lowell
Futures Options & Commodities Specialist, Mt. Vernon Research Everywhere you look in the financial media right now, there's always someone talking about the "stock market woes," "increased volatility" and of course, the "credit crunch." But while many investors curse the current volatility, it's actually a key element of one market in particular - the commodities market - where some of the biggest fortunes are made through futures commodities and futures options. And if you know where to look - and how to actually use the commodities market's volatility to your advantage - you can also cash in on this "secret society." Not many "ordinary" investors know this, but the commodities market can pack just as much wealth-building punch as the stock market - if not more. But because it doesn't receive the same attention as stocks, the commodities world is often branded a "secret society," shrouded in mystery, with stories of people losing their homes, or having 5,000 bushels of wheat dumped on their doorsteps. But this couldn't be farther from the truth. And I'll debunk those fables, bust myths, and give you the scoop on the commodities markets - and how to trade them profitably. Now, let's get to the basics... Commodities And The Breakdown Of Futures Commodities Commodities are mostly physical products that we use every day. That includes coffee, sugar, cocoa, orange juice, wheat, corn, and even pork bellies. But can you really trade these things and make money from them? You bet. And contrary to some popular myths, it's not that difficult to learn how. Just as you can trade stock options, you can trade the above-mentioned commodities through regulated futures commodities and futures options contracts. You're just speculating on the future direction of these commodities, then buying or selling futures commodities or futures options contracts to do it. A futures commodity contract simply specifies that a certain amount of a commodity must be delivered to a certain location by a certain date. But while there are players who will actually take or make the delivery of the physical products, we'll never be doing that. We're considered the "speculators" of the commodities markets. For us, futures commodities and futures options contracts are just a way to profit on the movements of commodity futures and options. There are two other groups besides us... The Commodity Market Chain & Where We Fit In - Hedgers: These are the farmers who grow the crops and sell them at harvest time. But since they don't know what price they'll get, they need to lock in a certain price now. So they sell a futures contract that guarantees them a specific price for their crops.
- End Users: These are the companies that make products out of the crops. For example, Kelloggs uses corn and wheat to make breakfast cereals, while Tropicana uses oranges to make orange juice. Since they need to lock in production costs in advance, they buy futures contracts and secure a buy price now, instead of being at the mercy of the open market when they're making their product.
Speculators like us fall in the middle. We're there to provide bid and ask prices for other speculators, hedgers and end-users and profit ourselves. So how are commodities used and priced and how do we access them? Two Key Differences For Trading Futures Commodities Just as you need to open a stock trading account to trade stocks, you need to open a commodity trading account. At present, stocks and commodities are regulated differently and you can't combine the two in the same account (although a few firms are moving towards that). Once you have a broker, you're free to trade. However, there are a few key differences between commodities and stocks. - Expiration Dates: Unlike stocks, which you can hold forever, all futures commodities and futures options contracts have an expiration date. If you trade stock options, you'll be familiar with this. But whereas stock options expire on the third Friday of every month, futures options have varying expiration dates, which are commodity-specific.
- Point Multipliers: With stock options, each contract is equivalent to 100 shares of the underlying stock. But with futures options, one option contract is equivalent to one futures contract. Also, futures commodities and futures options don't all have the same point multiplier. Every commodity is different.
For example, crude oil has a minimum price fluctuation of $10 per point with its options contracts, while orange juice has a $1.50 point minimum price fluctuation. Corn, wheat and soybeans have a $6.25 minimum point value, while coffee has a $3.75 per point minimum.
Here's a great website that gives all the different point values, symbol codes, and trading times for most commodities. Don't rue stock volatility and curse market unpredictability. Commodities can bring a refreshing change... The Commodities Market: 4 Reasons Why You Should Trade Commodities The commodities sector is actually a very beneficial area of the financial marketplace to invest in - and is a lot easier than stocks. Let me tell you why... - Supply & Demand Economics = Predictability: The commodity markets tend to move in more predictable, smoother patterns, compared to stocks. That's because their moves are based on supply and demand. For example, many food commodities move according to growing patterns, seasonal tendencies and weather. Prices are based on how well the crops are growing and how much supply is currently in storage. So when predictable natural events like hurricanes or droughts affect that situation, you can take advantage.
- Corporate-Less Commodities: Compared to stocks, commodities have no firms or CEOs running the markets, so the chances of corruption or number-fudging are greatly reduced. In addition, there are no volatile quarterly earnings reports to worry about.
- Fewer Outside Influences: We've heard a lot recently about whether the Federal Reserve should stabilize volatility by cutting interest rates. No such debate in the commodities market, though. And commodity investors don't have to contend with a mass of misinformation and rumors in Internet chat rooms, or what Jim Cramer is recommending on his "Mad Money" show. How are you supposed to project a stock's next move when you have all these outside factors jerking prices around?
- Mammoth Market Mitigates Risk: Although there are government reports to contend with in commodities, they typically only show how a commodity is progressing in the growing cycle. And although you may read about a hedge fund trying to control a certain futures contract, the commodities market is so large that a hedge fund's influence may only be short-term.
Investing In the Commodities Market: Hit The Exchanges And Branch Out Lastly, take a look at the various commodity exchanges online. Just as stocks trade on the NYSE, Nasdaq and AMEX, commodities also trade on different exchanges. The four major ones are: - The Chicago Board Of Trade (CBOT).
- The Chicago Mercantile Exchange (CME).
- The New York Board Of Trade (NYBOT).
- And the New York Mercantile Exchange (NYMEX), where I worked as a market maker on the trading floor for six years.
You can find anything you want about the various futures commodities contracts by visiting the exchange websites. Plus, they offer a wealth of free information in the form of live and archived webinars. In today's rocky stock market climate, commodities represent a viable and profitable alternative to stock investing, allowing you to cut through the fluff and use volatility to your advantage. You may even find them easier to trade, just as I do. Lee Lowell Today's Smart Profits Action Center - Here's a question I get asked all the time by friends, colleagues, and attendees at the investment conferences I speak at: "Why do you gravitate more toward the commodity market, while trying to stay away from stocks?" Great question. And a simple answer for it. While many people make a pretty good living trading stocks, and have increased their net worth, I've personally found that in my 15 years of being a professional trader, the wealth I can build up from investing in commodities greatly surpasses stock market returns. I explain why I think the commodities world offers more financial advantages than stocks in Smart Profits #410, Investing in Commodities: Four Reasons Why Commodity Investing Is Better Than Trading Stocks.
- Every day, millions of investors put their money at risk by relying on bland, "one-size-fits-all" information. America's 8,500 hedge funds pour billions into risky bets. Thousands of economists and analysts dish out "expert" advice. However, none of them know the inner workings of the trading floor and know how to profit from how the market works, not what it does. But Lee Lowell spent six years as a market maker on the trading floor of the NYMEX, one of a few who set the prices for the world's biggest commodities. Now, you can use this rare, rich source of knowledge to win on 80% of your trades... guaranteed. You'll even know your risk and reward up front.
Related Articles: - Corn Commodity: Cashing In With Sales Up 170% On The Government's Best-Laid Ethanol Plan
- Commodities: How to Create Your Own "Mini Hedge Fund"
- The VIX and VXO: How You Could Have Predicted The Market's Recent Meltdown
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