5 Essential Commodity Trading Risk Management Strategies

Commodity trading can be exciting, but at the same time a bit intimidating. Let’s address the “intimidating” part of it. Specifically, the risk that comes with trading in particular.

This guide will specifically cover five of the most essential commodity trading risk management strategies. You can utilize these to your advantage - especially when you want to make consistent profit. Bear in mind that these strategies are not guaranteed to be financial advice.

We also encourage you to not label these strategies as “get rich quick” schemes. After all, we’re talking about risk and managing it properly. Let’s dive right in and discuss how to get it done.

Take diversification seriously

One of the common sense strategies for investing is diversifying your portfolio. The same applies to commodity trading. For example, you don’t want your entire portfolio to consist of one asset. Think about the old adage: do not put all your eggs in one basket.

So your portfolio should consist of commodities “A”, “B”, and “C” (for example). Meaning invest in gold, silver, or oil. Don’t let the whole portfolio be “gold, gold, and more gold”. Get the idea?

Diversification will help impact the adverse price movements. At the same time, your portfolio will be in better standing. Take a moment to research the commodities you’re interested in trading. As always, be sure to use the skill of due diligence as it is your best friend so you can stay out of bad trades.

Whether it’s geographical regions or market sectors, diversification will set you apart from other traders. Take it seriously and you’ll put yourself ahead of many novice traders who are making mistakes and trying to figure it all out.

Harness the power of hedging

Another risk management strategy to keep in your tool belt is hedging. Doing this will protect you against a commodity’s price movement. One way to do this is taking positions in the options or futures market. A commodity producer can use futures to lock in a price that is favorable for them - which can help them hedge against a decline in price.

If you are trading oil options and worry about potential price increases, you can purchase call options as part of your hedging strategy. What you’re doing is providing yourself certainty and stability, even when the market volatility is higher than ever.

Identifying and assessing risks

Traders should learn how to identify and assess the various risks that are tied to commodity trading. These include but are not limited to credit, operational, market, and legal and regulatory risks. So how are they defined?

Market risk entails price volatility and the supply and demand of a commodity. Meanwhile, credit risk pertains to defaults on financial transactions regarding a counterparty. Operational risks are tied to system failures, disruption in operations, and even human error. Finally, legal and regulatory risks involve violations of laws, regulations, and contracts.

You’ll want to understand and be aware of these risks. Once again, this is where due diligence comes into play. When studying different companies and organizations tied to commodities, you’ll want to learn about the pertinent information that will allow you to make informed decisions. Due diligence will easily help you identify and assess the risks that may exist.

Position size and stop loss orders

One of the most critical aspects of risk management is position sizing. If you are a new trader, you want to avoid risking a significant amount. Even as a seasoned vet, it may be a smart idea not to take reckless risks that may result in you losing it all.

As such, they should consider using stop loss orders. A stop loss is designed to mitigate risk by closing a position if an asset’s price dips down to a specific price. When setting up an order, be sure to set up a predetermined price that will trigger a stop loss (i.e - 10 percent lower than the purchase price).

Sure, you can take the loss. However, you won’t be able to lose everything. Use the stop loss to your advantage in every trade you do. It'll be one of your best tools in mitigating risk.

Monitor and adjust continuously and accordingly

Here’s the thing about risk management: it’s an ongoing process. With that in mind, you want to monitor your portfolio on a regular basis. There will be times when you can make the necessary adjustments to preserve your portfolio. This includes but is not limited to selling a portion of your assets or even adjusting trading strategies.

You should also consider assessing any risk exposures that may exist. A company or organization that may appear to be doing well now could be in trouble months or even years from now. Hence why you should continuously perform due diligence on them while you’re still holding assets linked to them (stocks, commodities, etc.). It will give you opportunities to cash out while you’re still ahead.

Keeping your finger on the pulse will separate you from those who stay sharp and take action at the first sign of real trouble. The others are those who don’t perform their regular due diligence and ignore warning signs. It may seem time-consuming, but it really isn’t as it can take at least a few hours a week to do simple research and check your portfolio regularly.

Let PermuTrade help with your commodity trading needs

At PermuTrade, we help new and seasoned commodity traders. If you are planning on trading commodities and don’t have risk management strategies in place, use these five that we’ve listed. We can also provide you with additional assistance.

PermuTrade focuses on physical commodities and even digital assets such as cryptocurrencies. When it comes to trading, it’s important to have the right strategies in place to help you achieve the success you want. Ready to see what we can do for you?

Contact PermuTrade today and we’ll help you with your commodity trading questions. Here’s to your success.