Exploiting in Commodity Trading, profit and loss potential

The concept of leverage in commodity trading has a largely similar to that achieved stock trading and odds.

Initial margins on raw materials are generally much lower as a percentage of the value of the contract, futures contract actions.

It is not uncommon to see margins starting at 3%, with a range up to 15% and this is what generates significant leverage when trading commodities.

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So it is not surprising that many traders of raw potential get excited about the ability to control large futures contracts with a small deposit or investment of capital.

For example, let's say that the initial margin for a customer to third parties is $ 12,500 to trade of light, sweet crude oil on NYMEX.

So with crude oil around $ 100 and given that a contract represents 1,000 barrels, the merchant would control $ 100,000 of crude for the margin above. In other words leverage here is 12.5% or roughly 8 to 1.

Let s say that a trader decides to go long on December 8, when crude oil is $ 100, then you should be expecting the price to rise from this point.

A week later, for example, let s that the recent $ 700 bn Paulson rescue plan seems to be easing anxiety in financial markets and contribute to some recovery in confidence and economic activity.

The markets were more bullish on crude oil as they believe that demand will pick up again with this growing confidence.

There is also the approach of winter and OPEC announces that it will maintain its production levels unchanged.

All these factors, for example, this would cause the price of West Texas Intermediate crude oil on NYMEX futures to rise to $ 115.

At that point our dealer is sitting on a crude oil futures contract on December 8, with a value of:

$ 115 x 1000 = $ 115,000 barrels

If you would now decide, after a week in the market, to liquidate that position, she would have generated a profit of $ 15,000 (115,000 100,000) (excluding transaction costs).

So, just putting up $ 12,500 she has used the power of leverage in trade of raw materials to disable such contract decision in a gain of $ 15,000 within a week. This is a return on capital (ROC) by 120% in 7 days.

This is the power of leverage in trade of raw materials, a gain of 120% to merchant, although the price of crude oil went up to 15%.

What happens if the market goes the other way?

Remember, however, if the oil market did not react favorably to the Paulson plan, crude oil futures may have dived, let s say $ 92.50 compared to the same period of 7 days.

Now our commodity trader that went along the crude is not so happy. Of course, the other on the market that provides the crude oil to fall can go short oil, and would be happy at this point.

Why? Because the account is making a loss and she is likely to receive a margin call to restore the margin maintenance. If you have decided to cut its losses and liquidate its position, the result will be:

Buy 1,000 barrels (1 contract) @ $ 100 = 100000; Sell 1000 barrels @ $ 92.50 = $ 92,500 loss = $ 7,500

Here the merchant made a loss of $ 7500 and this entails a reduction of 60% of the original capital (initial margin) when the price of crude oil fell only 7.5%.

In this case is the power of leverage in trade of raw materials, only this time she created a loss of principal.

Clearly, the combination of derivatives and leveraging can make spectacular profits but equally important losses if the market goes the opposite way to the trader's position.

Leveraging can make the ride more volatile as exaggerates small movements in price action when the value of futures contracts.

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