In the fluctuating world of commodity trading, where money can be made or lost in an instant, risk assessment plays the most important role in strategic decision-making. Whether brokers or traders are navigating volatile markets or seizing lucrative opportunities, commodity traders rely on risk assessment to protect their investments.
What is the Role of Risk Management in Commodity Trading?
Members of a commodity risk management team strategise to stabilise commodity costs. The primary aim of risk management is to achieve the lowest possible price while ensuring the quality of the commodity remains high and that the supply is available from one or more sources.
Which Type of Risk is Most Commonly Associated with Commodity Trading?
The risk most commonly associated with commodity trading is price risk. Price risk refers to the potential for loss due to fluctuations in the prices of commodities.
The best way to manage this risk is with diversification. Traders can hedge their bets by investing in a variety of commodities rather than one single commodity. This helps to offset losses from one commodity with gains from another.
How Important is Risk Assessment in Commodity Trading?
With poor risk management, the inevitable short-term string of losses may bring trading to a halt. When trading commodities, risks can’t be avoided, but capital must be preserved to make money.
A risk-managed approach to trading commodities recognises that a risk is being taken but the risk must be limited in the short term to maximise the long-term opportunities. Lack of risk management is one of the most common reasons for failure.
Which Commodity is Best for Trading?
One of the best commodities to trade is gold. The gold market has lots of diversity and growth opportunities. It’s used in jewellery, by central banks, and jewellery giving rise to its market at different times within the global economy. The precious metal has traditionally been a safe investment and a hedge against inflation.
Is Commodity Trading High Risk?
Commodity trading carries a higher standard risk than most other equity investments. However, they can and have offered superior returns, but they still are one of the more volatile asset classes available.
How is Risk Managed in Commodity Trading?
In the manufacturing industry, commodity managers need to focus on the diversification of products and resources in addition to price targeting. To manage risk in commodity trading certain strategies can be implemented. This includes:
Monitor Price Forecasts
Frequent price jumps with base metals are not uncommon. These price jumps happen for a variety of reasons, but a few indicators include:
- Strong industrial activity coming from global manufacturing hubs.
- The health of the global economy.
- Momentum in global industrial sectors.
- Supply chain disruptions due to political or environmental occurrences.
Monitoring these indicators allows the commodity management team to anticipate potential changes to the prices and availability of commodities.
Implement Product Storing
Product storing can be seen as a type of investment in the product. When there is a large increase in the production of a certain commodity, the selling price reduces. Some commodity risk management teams will store the production until a more favourable price is obtained.
However, it’s important to note that this strategy comes with additional costs, including insurance, potential degradation, and storage.
Embrace Diversification
Diversification applies to products, facilities, raw materials, and more depending on the industry. Some types of diversification include:
- Diversification of material: Manufacturers use different alloys made from either zinc, steel, aluminium, or magnesium, and each base metal’s price can fluctuate depending on availability and supply, which makes diversifying sources and materials a useful strategy.
- Diversification of machinery: Manufacturers need many facilities to account for downtime, as well as the inventory of machinery needed for robust production capabilities.
What Can Happen When Trading Commodities Without Risk Management?
As discussed, risk management when trading commodities can be hugely beneficial. Without appropriate risk management, there can be huge losses which can then make events like the following happen:
- Loss of all trading capital or more.
- Losses that are too large given the overall financial position.
- Having to close positions in the account at the wrong time because it doesn’t have enough liquid funds available to cover the margin.
- A need for extended periods of profitable and prudent trading just to recover the losses and restore the trading capital to its original level.
The Role of Risk Management in Commodity Trading
Risk management in commodity trading is important. A risk management approach to trading commodities can help mitigate financial loss and provide security for traders and brokers. Lack of risk management is one of the most common reasons for failure.