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The “How to Trade Commodities Using ETFs " article examines and elaborates upon on commodities type ETF's with an examination of the differences these funds have with traditional commodity futures. Special emphasis is given to the risk, volatility, and return aspects.
Until recently, the sole fashion to invest in commodities was through futures contracts. Because of the leveraged aspect of this instrument, the risk reward ratio is extremely high. Given the volatile nature of commodity markets and the fact that the investor only puts up a small amount of money as a margin security against the total value of the contract, small movements in price can produce substantial quick profits or losses. If a contract value declines, the investor must always be prepared to come up with more funds to cover his exposure.
Diversifying commodities trading with ETFs
Individual investors now, however, can invest in commodities which exchange traded funds, or ETF's. In exchange traded funds, there is no leverage. ETFs operate similarly to common stock. You can go long or short, as they do not have any leverage. Your loss or gain is limited to the actual advance or decline of the price of the ETF. ETFs, essentially, try to copy an index and offer the any individual investor the return of the underlying portfolio represented by the ETF.
Lowered volatility with ETFs
Commodity-based ETFs do not lack volatility, but that volatility is nowhere near the level of individual commodity futures contracts. Currently, commodity-based ETFs are limited in number and often are based upon the common stock of companies with a strong underlying commodity exposure. The Materials Select Sector SPDR Fund (IGE) is a commodity type ETF that includes companies in packaging, containers, construction materials, chemicals, mining, paper, and forest products. Another ETF is the Energy Select Sector Index (XLE). Nearly all of holdings in this portfolio is in energy stocks.
ETF options
There are limited pure commodity ETFs and these appear limited to gold, silver, and crude oil. Some ETF's have recently been introduced based on indexes, such as the Deutsche Bank Commodity Index Tracking Fund (DBC).
Given the growing popularity of ETFs, it is more than likely that the variety of commodity type ETFs will only grow in number. This product offers the investor an alternative to commodity futures that are less risky and volatile.
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