Unprecedented events, such as political unrest, supply chain disruptions, and recession fears, have recently had an impact on the commodity markets. These events have led to significant price shocks and dramatic changes in a commodity trader’s financial performance. Because of the complexity of the commodity markets, the risk is now more important than ever for determining how well a business performs. With new players entering the market to capitalize on the volatility and regulators changing the ways in which it governed these markets, the Commodity market has also grown more complex. So for any traders it is important to have a proper knowledge of risk management in commodity trading.
Increased scrutiny of regulators and market participants as we transition to a low-carbon economy adds to the complexity. Commodity traders are now challenged with a wider issue regarding the adoption of a suitable sustainability strategy and sustainability reporting requirements to their stakeholders in addition to managing the volatility of commodity prices.
Gaining knowledge of the company’s performance and potential opportunities requires a strong control environment, comprehensive trading systems, and reporting solutions. For Commodity market traders to make effective strategic and operational decisions, timely and accurate risk reporting is essential.
What Do Commodity Risks Management Entail?
Commodity risks are an essential component of commodity trading due to the volatile nature of commodity pricing. Large price swings are a result of market forces like supply and demand, which can have a negative impact on the commodity market. Especially considering how complex these markets are becoming.
Lack of Experience:
One of a trader’s biggest types of risk when trading commodities is undoubtedly inexperience. Many people enter the commodity market without even having a basic understanding of it. They are persuaded that trading in commodities is the simplest way to make quick money for their friends, family members, or the media.
Traders initially make rash decisions due to their inexperience. They put too much money into the wrong endeavors. The end result is that the majority of them lose all of their capital in the first few trades.
Trading in commodities is a science unto itself. The majority of successful commodity traders still view themselves as learners despite having years of trading experience. As a result, believing that one is knowledgeable in a field after reading an article or listening to a story is erroneous.
High Volatility:
People invest in commodities because of their volatility. Commodity prices can fluctuate on an hourly basis. People invest in commodities in order to profit from these fluctuations. As the saying goes, the greatest blessing can also be the greatest curse.
Similarly, volatility is the most dangerous risk factor in commodity trading. Commodity prices can fluctuate at any time. This can be devastating for those who had hoped for the opposite outcome. As a result, one of the most dangerous commodity trading risks may emerge.
Assume you bought some gold bullion in the hope that the price would rise the next day. On the contrary, due to day-to-day price fluctuations, the price of gold falls the following day. This could imply that you have suffered a contract loss.
While all commodities are volatile by definition, this risk factor is more prominent in some commodities than others. Precious metals such as gold and silver are more volatile than raw materials, such as steel.
Unforeseen Risks:
Unforeseen risks are a significant component of commodity trading. These are the most difficult risks to manage because it cannot predict them in advance. Unforeseen risks include a random third-party event that causes the price of a commodity to rapidly increase or decrease.
These events could be natural and could occur at any time to any commodity. Earthquakes, unexpected rainfalls, droughts, unexpected government policies, business events, natural disasters, and so on are examples of such events.
For example, when poultry diseases such as bird flu become common, people stop buying poultry products such as chicken meat and eggs. This causes a sharp drop in demand and a significant drop in prices.
Finding Leverage:
Commodity trading provides a great deal of leverage to traders. However, novice traders frequently abuse this gift, turning it into a commodity trading risk and risk management.
The amount of money you deposit as a down payment for the actual price of the commodity is referred to as the margin or leverage. For example, if the price of a commodity is X1000 and the leverage is 20%, you would only need to put in X200.
This is not to say that it took the remaining funds for granted. Consider it a loan from the commodity exchange. So, if the price of the commodity rises by 20%, to X1200, you have made a profit of U00 and doubled your investment.
However, if the price of the commodity falls by 20%, to X800, your entire investment is lost. Most traders are incapable of properly utilizing this gift of leverage. If the margin is 10%, they may purchase ten contracts of X1000 to control $1,000,000. What they don’t realize is that, while there is a good chance of profit, even minor market fluctuations can wipe out their entire investment.
Emotional Impact:
While it should make commodity trading decisions after careful market analysis, traders are frequently influenced by their own emotions, which can cause some types of risk. People are frequently unable to accept a loss.
They continue to hold on to their contracts in the hope of making a profit simply to avoid realizing that they made a mistake. People will sometimes raise their stakes even after losing in order to make up for their losses. This results in greater losses.
People are sometimes so influenced by their emotions that they borrow money to invest in commodity trading to make up for their losses. This not only leads to more losses but also puts the person in debt. Commodity trading can easily become an addiction, so it is critical to maintaining control over it.
These commodity trading risks are inherent in commodity trading and should always be considered when making decisions and do proper risk management in commodity trading. If you manage them correctly, you will become one of the most successful traders you have heard about!