How to Trade Commodity Futures

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How does commodity futures trading work and what are the risks? -- C.H.

Commodity futures trading involves buying and selling contracts for the future delivery of physical raw materials, explains Mark Hansen, director of trading at New York-based specialty commodities firm CPM Group.

Examples of frequently traded commodities include gold, copper, soybeans and even live cattle or pigs. "The futures market allows producers and consumers of each product to engage in risk management," says Hansen.

Indeed, that is why the futures exchanges were developed. A farmer wanting to be sure of a price for a product would sell a contract for future delivery at a price agreed to now. By doing so he, or she, would remove the risk that prices on the delivery date would be lower.

The Trading of Futures Contracts

The contracts are typically bought and sold by traders on exchanges such as the Chicago Mercantile Exchange, part of the CME Group(CME). The trading occurs either on the exchange floor or electronically.

Investors Beware

Although making the actual futures contract trade is similar to buying or selling shares of a stock, the trade is different in an important way. Unlike trading shares of stock, almost all futures are bought and sold on margin . Since only a fraction of the face value of the contract needs to be paid upfront, it means that profits and losses are magnified.