Commodity Investing Plus Leverage Equals…?

Utilizing commodity investing plus leverage can go either very well or very badly. Commodities are prone to wild speculation. as seen in 2007 to 2008 when oil prices hit $147 a barrel. This was also witnessed in the “Silver Thursday” of 1980, when two billionaires ended up getting hit with a margin call that even their resources could not cover. This situation, which inspired the movie “Trading Places,” become an infamous example of how using leverage on a trade that fails can destroy even the most formidable trading force.

Why Use Leverage on Something So Risky?

Investors will utilize leverage--or credit, in other words--in order to amplify their returns. If someone invests $100,000 for example and utilizes $50,000 of margin, there is a total of $150,000 in play. If he has a 100 percent return equaling $300,000, using the margin makes sense. However, if the investor loses everything, he is out not only the original investment but also the margin balance. Although brokerage firms and exchanges have a minimum margin requirement (cash on hand to cover a percentage of the margin being used) for securities, it should be noted that greed will take over at some point--the investor can be blinded by the potential returns versus real returns. A well-disciplined trader with years of experience may even occasionally fall victim to human fallibility. More often than not, though, investors motivated more by emotion than reason will not only fail to do their due diligence but make critical mistakes when making the trade.

How Can I Avoid Disaster . . . on Credit?

The commodities trade is a very lucrative and very exciting segment of the financial markets to play. Those with the fortitude and foresight to make the best trades can walk away with riches beyond their imaginations; however, for every one tale of triumph, there are a hundred of woe. Commodity investing should match one's style of investing and appetite for risk. Therefore, one should analyze his financial situation and make sure that this is the type of arena that he wants to enter.

In addition, to save tons of grief down the line, one should do exhaustive research before making any trade. Making a prudent trading decision will take hours of research. (Bear in mind that hedge funds and institutions employ armies of analysts working 15-hour days equipped with training and resources far beyond what the average investor can even begin to dream of mustering.)

If leverage is to be used, it should be done in increments and only when absolutely necessary. This is where dollar cost averaging (employing capital at different points, averaging out a specific amount in the long term) would come into play to keep risk to a minimum.

In addition, an investor should not let his emotions get the best of him. Human beings are creatures of emotions, but no amount of crying, cursing and praying to holy deities will reverse a trade going the wrong way. Keeping an entry and exit point so that initial capital and profits will be protected is an excellent way to minimize risk in an already very risky market.

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