Learning to Trade Commodities: Choosing Which to Start Trading First                 

For those who are new to high-stakes gambit of futures and options and who are just learning to trade commodities, one of your first questions may well be “which commodities should I trade?”

Answering that question correctly can be instrumental in getting you off to a good start but before doing so, there are five other questions you should probably answer first.   Learning to trade commodities successfully also means learning about yourself, and recognizing your unique trading position.   Your answers to these questions can serve as a decision-making guide as you compare the margin rates, maximum daily price move, activity level and short- and long-term volatility level of specific commodities futures.

1. How much capital do I have to begin trading with?
2. What profit level am I hunting?
3. How much risk can I take without driving myself, my family and my friends insane?
4. What type of trading suits my personality and time availability? Day trading? Swing trading? In for the long haul?
5. Do I know anything about anything?

Before we get into those details, however, take a look again at question 5. Forget about what your mother might mean by this question and consider…are there any commodities you might already know a lot about due personal or business activities and interests? Do you already watch lumber prices because you’re in construction? Gold prices because you’re a jeweler or avid collector? Gas prices because you drive a cab? Consider starting with what you know.

As the beginner learns about trading commodities, here is what should be considered when choosing which to trade:

Margin: The Unforgiving Variable
Each commodity has a unique margin level required to make a trade. The margin will be the amount of money you initially invest and is related to the amount of money you’re putting at risk. For example, if you have $5000 dollars and you wish to buy a futures contract in natural gas with a margin of $9800*, keep wishing. In the mean time, you’ll need to buy a contract with a margin not greater than $5000.

Since you’re just learning the commodities futures and options market, it may be wise to limit your investment (and potential losses) to a start-up level, even if your total portfolio is substantial. There are several general classes of commodities that are traded in the futures markets, each with its own characteristics, including typical margin levels.

Grains (which include Corn, Wheat and Soybeans), Meats (Hogs, Cattle, etc) and
Softs (Sugar, Cocoa, Coffee, etc), collectively called "Agricultural" may be a good place for the beginning trader to start. Many consider margin levels here to be reasonable, and there is enough variety in activity levels and volatility levels to suit most investment styles. Currencies, financials and indices also offer plenty of activity combined with a broad variety of margin levels.  Gold futures and other precious metals, on the other hand, may be relatively high-ticket investments, as are energies. Crude oil happens to be the world’s most actively traded commodity, but with an average margin of over $10,000*, crude oil futures tend to be the realm of big Wall Street firms and pension funds.  As such, for this article, we’re going to focus on the ‘softs’ as a good option for those just learning to trade commodities.

Trade Volume: Looking for Liquidity
When you get into a commodities investment, you really want to know, that you will be able to get out when you choose. A stop-loss order won’t stop the losses if no-one is buying. And you can’t realize your gains if you’re stuck holding on when the roller coaster changes direction. In addition, the existence of a large number of active movers and shakers has a tendency to smooth out a market’s wild rides, while a less active market can be more difficult to bring back into line if it starts swinging wildly. Commodities that might not fit into the beginners portfolio due to volume include pork bellies, rice, lumber, oats, orange juice and feeder cattle.

But keep in mind that the popularity of commodities can be trendy and investors can be fickle. Today’s nobody may be tomorrow’s celebrity. It’s always wise to check with you’re your commodities broker/advisor, whose job it is to keep up with the latest information.

Food Cravings
Soybeans are a popular commodity and provide lots of liquidity. Although the margin for a full position in soybeans generally is close to the $4,000* mark (however, mini positions can be had for $250-$850*), their near cousin, soybean oil, is available for around half that amount. Soybean oil is less volatile than soybeans, which favored by day-traders. The reason for soybean oil’s reduced volatility and lower margin is probably the wide variety of products that depend on it as an ingredient. Commodities with broad usage tend to be tamer in the short-run with well-defined trends.

Margins are even lower on lean hogs (approx. $1400*) and live cattle ( approx. $1100*), and these two commodities move quickly enough to keep a day trader smiling, yet slowly enough to allow a beginner to keep up. Because these meats are staples in diets around the world, they offer fairly reliable trending patterns. Major moves, once they begin, tend to make sense with the fundamentals.

Sugar, with average margins between $1400* and $1500*, is affordable, but its stately price progressions are not well suited to day trading. It trends well, however, making it a good prospect for investors with a little time to wait. For day traders who skip the sugar, coffee commodities can be a good way to wake up a morning with fast movements and margins around $3,000*.

And good old corn, with its many uses, is also a popular commodities assets for those learning to trade. It is very liquid and margins range around $1,600* (or as low as $300-$500* for minis).

That said…

Of course, nothing is carved in stone and this isn’t the entire story. For one thing, if you really want to invest in metals on a grain-fed budget, commodity options are…well, an option. Up to date research is a essential, even if you’re comfortable and experienced in your niche.  Markets and trading conditions constantly change and specific commodities participating in the liquid futures market may change over time. For example, ethanol has only recently become a presence on the exchanges and in five or ten years, we may see active trading in things like water rights and pollution rights.

The bottom line is that for those just learning commodity trading, some commodities are going to be better to start trading than others.  Considering margin, trade volume and what you my already know about a market, can go a long way in helping you develop a good initial investment strategy.

* Rates shown are for comparison purposes only and are not indicative of actual commodity margin rates for any time period in specific.