Commodity markets can be broken down into three main categories: metals, agricultural, and energy. Each sector has a unique set of contracts that are used by industrial interest, commercial interest, and speculators. All market participants play an important role in the marketplace. Some of the underlying commodities that make up each category and their subgroups are:
Metals market futures contracts:
- Precious: gold and silver
- Ultra precious: platinum and palladium
- Industrial: aluminum, copper, and HRC steel
Agricultural market futures contracts:
- Grains: corn, soybeans, wheat, rice, and oats
- Softs: coffee, sugar, orange juice, and cocoas
Energy market futures contracts:
- west Texas intermediate crude oil (light sweet crude), brent crude oil, reformulated gasoline (RBOB), natural gas, diesel, ethanol, heating oil, propane, liquid natural gas, and electricity
Each market is used by speculators as well as commercial and industrial interests. One without the other is like peanut butter without jelly. Speculators use markets without any direct interest in the underlying commodity. They are there to grow capital either as a career in trading for profit, or as an alternative to more traditional means of finance. Commercial and industrial users of market futures use these contracts to hedge risks associated with price exposure. A farmer or miner can use futures to hedge forward production. Essentially a producer would sell their production equivalent on the futures market and buy the contracts back once the production is produced. Their gains or losses would be offset by perceived gains or losses from the cash market exposure. The hedgers use the futures markets to secure a cash market price for a forward date. The consumers, such as grain mills or fabricators, would simply do the opposite. They can hedge their input costs by buying contracts on the futures markets and selling them back at a later date.
The whole notion of hedging is based on one idea. The hedgers have risk exposure. By using the futures markets, they unload some of their risks to market participants who are willing to take it on. Who takes on market risks? The answer is the speculator. Hedgers reduce risks, while the speculators take it on. Think about it like an insurance policy. The hedgers buy the insurance policy from the speculators who act as the insurance company. The speculators make the market liquidity and they rely on the hedgers need to reduce risks. The hedgers need the market liquidity to move in and out of positions. Both speculators and commercial/industrial traders (hedgers) of futures markets play essential roles.
Trading in futures and options involves a substantial degree of a risk of loss and is not suitable for all investors. Past performance is not indicative of future results.
