Risks of trading commodities

Any form of investing or trading involves risks and commodity trading is no different.

Two of the main risks to be aware of with commodity trading are:

1. Price risk

Price risk refers to the risks associated with the fluctuations in commodity prices.

Commodity prices can be extremely volatile and while this volatility can create trading opportunities, it can also be a risk factor.

Unfavourable price movements can result in significant losses for traders.

If you do not have sufficient funds in your account to cover potential losses, your positions may be automatically closed.

2. Leverage risk

While leverage is a powerful tool that can magnify trading gains, it can also work against you by magnifying trading losses.

If a large amount of leverage is used to trade, even a relatively small price movement in the wrong direction can result in substantial losses.

It’s important to be aware that losses can exceed the amount invested.

Risk management strategies

You can never eliminate risk completely when trading commodities, however, you can reduce it by focusing on risk management.

Three strategies that can help reduce risk include:

1. Determining your optimal position size

Before you start trading commodities, you should determine your optimal position size for each trade.

A good rule of thumb is to avoid risking more than 2% of your capital on any single trade. Trading more than 2% per trade could expose you to losses that are hard to recover from.

2. Putting stop losses in place

Stop losses are a fundamental component of a robust risk management strategy.

Stop losses help minimise trading losses by closing out losing positions before large losses build up.

3. Diversifying your portfolio

A portfolio that tracks a wide range of assets will have a lower level of risk than a portfolio that simply focuses on one asset.

By diversifying your portfolio across multiple asset classes such as stocks, ETFs, bonds, and commodities, you can lower your overall portfolio risk.

Reprinted from eToro, the copyright all reserved by the original author.