| Answer:
Dear
Bob,
I'm
glad you asked these questions, as these are areas
in which inexperienced investors can lose money --
I'm not saying you should avoid them; I just want
you to be informed before you open your wallet. You
might do very well, in fact, as Hillary Clinton once
did in cattle futures.
Also,
since you are the 100th person to write in and ask
a question, we wish to say "thank you" by sending
you a copy of one of my books.
Commodities,
unlike stocks which represent ownership in a company,
are actual raw materials and agricultural goods, including,
in alphabetical order: cattle, coffee, copper, corn,
gold, heating oil, hogs, lumber, silver, soybeans,
wheat, etc. Commodities fluctuate in price based on
supply and demand and, in some cases, weather conditions.
Most
producers and major users (but not investors) buy
and sell commodities in the cash market which is also
called the spot market because the full price is paid
in cash "on the spot." They also use futures contracts
(explained below) to hedge against future price fluctuations.
Investors
participate in the commodities market through futures
or to be more exact, futures contracts. They
try to predict in advance the future price movement
of a specific commodity.
Futures
contracts are legal agreements to either buy or
sell a particular commodity within a given time period.
(You can also buy futures contracts for stock indices,
bonds and currencies.)
Futures
contracts run for varying lengths of time. Trading
is done on exchanges around the world.
When
you purchase a futures contract, you are speculating
on the "future" price of a commodity. There are two
types of futures: long and short.
A
long position means you think the price of
the commodity will increase.
A
short position means you expect the price of
the commodity to drop in price.
A
futures contract obligates the buyer to buy and the
seller to sell unless the contract is closed out by
an offsetting sale or purchase to another investor
before the so-called settlement date.
The
greatest appeal of trading commodities lies in the
impressive amount of leverage they provide.
Your broker will require you to meet certain net worth
requirements and to make a margin deposit. But the
cash requirements are low -- when you purchase a commodities
futures contract, you don't have to pay for the whole
contract, you put up a small amount of the actual
value of the contract -- 5% to 10%, depending on the
commodity and the broker's requirement.
Let's
say you buy a wheat futures contract worth $30,000.
You might have to actually give your broker only $3,000.
This is known as leverage and it is a high risk move.
Unlike most stock market investments, your holding
could be wiped out in a day or a week.
If
the price of wheat goes up, you'll make money. If
the price goes down, you'll lose money. If the price
drops below the amount you put up ($3,000), then you'll
get a margin call from your broker asking you to make
up the difference.
Excellent
Information...
Before
you make a move into the commodities market, I urge
you to read the information in The
Wall Street Journal Guide To Understanding Money &
Investing, available at libraries or in paperback
for $15.95. It's published by Lightbulb Press, a division
of Simon & Schuster. It not only has clear diagrams
explaining the process but also several easy-to-follow
examples of trades, including money-losing trades.
About
Options...
You
also asked about options. Please click
HERE and read a prior column on the topic.
Then,
take a look at "Options on Futures Contracts," a clearly
written and helpful guide published by the Risk Management
Agency of the U.S. Department of Agriculture (www.rma.usda.gov).
In the search box, type in the name of the publication.
|
