Many investors feel afraid of investing in commodities. Commodities investing over the years has been seen as a risky asset class. Now, if we make a statistical comparison of commodities as an asset class with the other asset classes especially with stocks, we find them to be no more risky. There risk is at par with the other asset classes. But investors have shunned commodities over the years as an investment for whatever reasons. Stocks have always been the most preferred method of investment.
Let's do some comparison as this is quite baffling as the performance of commodities has been much superior to that of stocks over the years. Dow Jones Industrial Average (DJIA) tracks the performance of 30 blue chip stock listed on NYSE. It is a price weighted average. On the other hand Dow Jones-AIG Commodity Index tracks the performance of a basket of commodities.
In 2002 alone, DJIA had a negative return of -7% as compared to the Dow Jones-AIG Commodity Index return of 26%. Between 2002 and 2005, DJIA had an average of 7% return. However, Dow Jones-AIG Commodity Index had a return of 21%. This is something psychological.
Investors are afraid of what they don't know. Many investors tend to stick with an investment that they know even if that investment doesn't perform well for them. For example, in the recent stock market crash of 2008, investors lost trillions of dollars. In 2000, when the dot.com bubble burst, investing public lost something like $3 Trillion. Yet, no one warns of stocks! Many investors are afraid of commodities because they don't know much about them.
When you trade stocks, you have to have 50% of the capital in your trading account before you can enter a position on margin. In other words, a leverage of 2:1 is maximum permissible. Now margin requirements for commodity futures may vary. There are dozens of commodity futures contracts that you can trade.
Suppose, you decide to trade Soybean Futures on CBOT (Chicago Board of Trade). The margin requirement is only 4%. What this means is that with only 4% in your trading account, you can buy $10,000 worth of Soybeans Futures Contracts. Now if the trade goes your way, you make a hefty profit on a very small amount.
But hey, leverage is a double edged sword that cuts both ways. If the market goes the wrong way, you can lose a lot more than your principle. Anything you do in life is risky. Even your marriage! Love can turn sour and end up in a messy divorce. But that doesn't mean you shouldn't love.
Commodity market is going to be in a boom for many decades in the 21st century. The population has increased. The demand for commodities is at an all time high while the supply is limited. You can take part in this commodity boom by position yourself now!
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