How To Trade Red Hot Commodities

This is a relatively new opportunity. Most commodity ETFs have been available for less than two years. Before that, futures contracts were the only way to invest directly in commodities. But futures are short-term bets and too risky for most individual investors. Another alternative is to buy shares of companies involved in the corresponding industry. For instance, you could buy an oil driller to gain from rising energy prices. But that doesn't always work. Often, related industry stocks don't follow commodity prices.

Commodity ETFs usually track indexes reflecting futures prices. For gold and silver, ETFs actually track the prices of the metals. But the ETF shares do not trade at the commodity prices. For example, a crude-oil ETF doesn't trade at the same price as a barrel of oil. Instead, it trades at a specified fraction of the barrel price.

Nevertheless, ETF prices move by almost the same percentage as the commodity. For instance, if oil prices move up 10%, so would corresponding ETFs. ETFs have expenses that keep them from fully replicating the commodity returns. For instance, a 1% expense ratio would subtract 1% from an ETF's annual return. Because most EFT expense ratios run below 1%, that's usually not a concern.

You can use MSN Money's ETF Performance Tracker to see how commodities are performing in general and to determine which commodities are outperforming. Except for precious metals, all commodity ETFs are listed in the "Specialty-Natural Resources" category. So, select that category and then choose the "show all" option.

The basic strategy execution beshind such concept is that Commodities are notoriously cyclical. That means it's probably a bad idea to assume that crude oil and natural gas will continue to outperform other commodities. Instead, diversification should be the name of the game. Yes, you'll probably miss a big move by diversifying, but investing success is more about avoiding big losses than it is about scoring home runs.

Before concluding please ensure that, Over the years, some very smart people have gone broke playing commodities. So, don't use the money that you'll need for retirement or to put your kids through college.

Also, experts advise that you should never allocate more than 25% of your funds to any one sector. Given that commodities are particularly risky, I advise reducing that limit to 10% or 15% for them.

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