Commodities traders fall into two broad categories: hedgers and speculators. Hedgers are business firms, farmers, or individuals that enter into commodity contracts to be assured access to a commodity, or the ability to sell it, at a guaranteed price. They use futures to protect themselves against unanticipated fluctuations in the commodity's price. Thousands of individuals, willing to absorb that risk, trade in commodity futures as speculators. They are lured to commodity trading by the prospect of making huge profits on small margins (futures contracts, like many stocks, are traded on margin, typically as low as 10 to 20 percent on the value of the contract).
Speculating in commodity futures is not for people who are averse to risk. Unforeseen forces like weather can affect supply and demand, and send commodity prices up or down very rapidly, creating great profits or losses. While professional traders who are well versed in the futures market are most likely to gain in futures trading, it is estimated that as many as 90 percent of small futures traders lose money in this volatile market.
Commodity futures are a form of "derivative" -- complex instruments for financial speculation linked to underlying assets. Derivatives proliferated in the 1990s to cover a wide range of assets, including mortgages and interest rates. This growing trade caught the attention of regulators and members of Congress after some banks , securities firms, and wealthy individuals suffered big losses on financially distressed, highly leveraged funds that bought derivatives, and in some cases avoided regulatory scrutiny by registering outside the United States.
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This article is adapted from the book "Outline of the U.S. Economy" by Conte and Carr and has been adapted with permission from the U.S. Department of State.
