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What is Commodity Trading?

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Many commodities (bulk products such as corn and wheat) carry an inherent risk of price fluctuation for both the buyer and seller. By allowing commercial producers and consumers to lock a price through the purchase or sale of commodity futures, commodity trading offers commercial producers and consumers an opportunity to hedge their bets against a significant drop or rise in the price of a particular commodity. Futures contracts are standardized by commodity exchanges and are purchased or sold through various clearinghouses.

A significant portion of commodity traders are either commercial producers, like wheat farmers, or commercial consumers, such as a bread manufacturer. However, commodity exchanges also attract speculators. Speculators do not own commodities, nor do they plan to use the commodities; rather, they gamble that the price of a commodity will rise or fall. They then purchase or sell commodity futures accordingly. Although the principle purpose of the futures market is to provide producers and consumers with greater confidence, speculators also play a role. Their willingness to purchase commodity futures provides farmers, for example, with a buyer for their futures contracts.

Futures traders do not put up the total price of a futures contract; rather, traders deposit an exchange-determined amount with a clearinghouse. That deposit is usually between 2-10% of the contract value and is known as the margin payment. The margin ensures that traders can fulfill their financial obligations and is matched each day against the market. If you purchase a futures contract and the price of the futures declines, the amount of money in your margin account will also decline. The commodities exchange also establishes a maintenance margin as a type of threshold. The maintenance margin is set at a price equal to or lower than your initial margin deposit, and if your account falls below that maintenance margin you�re required to deposit additional funds in order to maintain the account.

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