TradingKey - The uncertainty surrounding U.S. tariff policies and weak economic data has heightened concerns about an economic slowdown and persistent inflation.
The U.S. stock market has experienced significant volatility, with the S&P 500 index fluctuating. Investors fear that President Trump’s tariff plans could fuel inflation and a global trade war, prompting safe-haven funds to flow into the gold market and driving higher international gold prices.
Meanwhile, fluctuations in the U.S. dollar index also impact commodity prices, as most commodities are priced in U.S. dollars. For commodity investors and enterprises, closely monitoring changes in U.S. economic policies and data is crucial to proactively adjusting investment strategies and risk management measures in response to potential market volatility.
Risk management strategies aim to minimize potential losses while maximizing market opportunities.
Given the inherent volatility of commodity markets, traders and investors must adopt a comprehensive approach to safeguard their investments from adverse price fluctuations.
Let’s Learn About Several Common Risk Management Strategies in Commodity Investing.
What is a Stop-Loss Order?
A stop-loss order is a commonly employed device for mitigating risk in financial trading.
It is a pre-set trading instruction by the investor that automatically triggers when the price of the commodity reaches or breaches the specified stop-loss price, executing a market or pre-defined price order to close the position.
This way, you won’t have to scramble during significant market fluctuations, nor will you need to worry about making erroneous decisions due to emotional impulses.
(Source: Freepik)
What Methods and Techniques Can Be Used to Set Stop-Loss Orders?
Adjust Stop-Loss Levels According to Market Conditions
Different markets exhibit varying sentiments. For instance, the gold market is heavily influenced by geopolitical events and economic data, leading to significant price fluctuations.
In such cases, you may need to set a wider stop-loss margin. Conversely, agricultural markets tend to be more stable; for commodities like corn and soybeans, where price movements are less extreme, you can afford to set narrower stop-loss levels.
Consider Your Risk Tolerance
Evaluate whether you are a conservative or aggressive investor to determine how tight or loose your stop-loss settings should be.
Utilize Technical Analysis Tools
Support and resistance levels are common reference indicators.
When buying commodities, it’s advisable to set your stop-loss price below key support levels.
For example, when trading copper futures, establishing a stop-loss based on these support levels is beneficial; technical indicators like moving averages and Bollinger Bands can also assist in determining stop-loss points.
How Does Position Size Affect Risk Exposure?
Position size refers to the quantity of contracts or assets an investor holds in the commodity market.
The size of a position determines both the amount invested and the potential scale of gains or losses.
For instance, if you buy 10 contracts of gold futures (a large position), a 1% increase in gold prices could yield profits of 10,000, while a 10,000. In contrast, purchasing just 1 contract (a small position) means that a 1% price fluctuation would only affect your capital by $1,000, offering less volatility but also smaller potential profits.
Establishing larger positions during favorable market conditions can significantly amplify profits.
However, if market trends deviate from expectations, losses will increase correspondingly.
Such heightened volatility increases the risk exposure for investors, leading to greater uncertainty in their portfolios.
How Should You Adjust Position Size Based on Your "Risk Tolerance"?
Large positions carry high risks; therefore, it’s essential to choose an appropriate position size aligned with your financial situation and investment objectives.
Experienced traders may consider increasing their positions compared to novice investors, who should be more cautious when sizing their trades.
(Source: Freepik)
What is the Importance of Diversification in Investment?
Diversification is essential in any investment strategy!
In commodity investing, you can diversify across different types of commodities as well as over time.
Cross-Commodity Diversification: For example, you can invest in crude oil, gold, and soybeans simultaneously.
When energy prices rise, agricultural prices may fall while metals could stabilize, helping to offset fluctuations within your portfolio.
Cross-Month Diversification: The price movements of copper futures can differ between the January and May contracts.
For instance, if you buy both the January and May contracts at the same time, the January contract might decline due to high inventory levels, while the May contract could rise due to expectations of increased demand during peak season. This way, overall losses can be mitigated.
How to Use Hedging in Commodity Investments?
Hedging is a popular strategy in risk management that entails assuming opposing positions to safeguard against possible losses due to price changes.
The concept is simple: for instance, if you're concerned about corn prices dropping during the harvest season, you could short corn contracts in the futures market beforehand.
If corn prices indeed fall at harvest time, profits from your futures position would offset losses from your physical holdings.
How to Implement It?
While buying crude oil futures, consider also purchasing "put options," which act like insurance against falling oil prices by giving you the right to sell at a higher price if needed.
Similarly, when going long on physical soybeans, shorting soybean futures would help lock in your purchasing costs.
