How Can an Investor Lose Money in a Commodities Trade?
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3 Major Ways to Lose in Commodities Markets
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Commodity trading is a high-margin opportunity that relies on precise knowledge and planning before entering a position. Trading losses are actually more likely than wins. The commodity trader's strategy is to find market moves of major trends. Thus, the winning percentage of a trade is low but the losses on the losing position are kept very low. Commodity trading commands the use of strict discipline and money management. The key is to ensure a small loss doesn't become large. A primary cause of losses is when a trader begins a trade with great conviction. The trade turns against him and rather than follow this plan, he disregards his stops while losses continue and a margin call is issued for more funds in the account. The error: is a lack of discipline. This is avoidable loss.
Trading Losses from Limit Up or Down Losses
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Another loss scenario that's nearly uncontrollable is the market up-or-down-limit situation. It's important for traders to know details of every contract they trade: point value, contract size and daily limit. This information is meant to help the trader define his money management so she doesn't inadvertently over-invest in a particular commodity. Limit trades occur when sudden, breaking news causes markets to fly past the daily limit imposed by the exchange. For example, if gold were at $900 and the limit were $75, trading would be halted until the next day for prices below $825 or above $975. In the case of silver after the Hunt Brothers fiasco, trading limits continued for several days and traders found themselves, (despite stops that could not be used) with major losses when the market finally did reopen. There is nothing a trader can do but prepare herself with ample reserves or reduce trading size for such occurrences.
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Trading Losses from Rolling Contracts and Cost of Carry
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Trading losses will naturally occur by holding long positions in a flat market (and short positions will gain in flat markets). This is because every futures contract assumes an interest rate cost due to using futures to buy a commodity rather than buying the commodity itself. This is why markets in futures generally increase in price. The variation is due to the implied cost of physically carrying inventory.
Futures and commodity traders must "roll over" or move from the front or current month to a later contract as the end of the contract month occurs. Transferring from one contract month (referred to as rolling a contract from the front month to the back month) to another means that the current month contract must be closed for a fee and a new month opened. This entails two brokerage fees and paying the difference between the bid and offered side as well. Again, in a flat market, this is unavoidable.
Trading is difficult. The futures market is more difficult because of the very high margin used. Trade carefully and diligently.
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