If you are a beginner to commodities, you should first read this comprehensive guide on Commodity Trading In Nigeria.
Types of Commodity Risk
There are several types of commodity risks that businesses and investors can face. They include:
- Price risk: Price risk is the risk of loss resulting from adverse price movements in a commodity. This risk arises when the price of a commodity changes in a direction that is unfavourable to a business or investor.
- Supply risk: This is the risk of loss due to supply disruptions that affect the availability of a commodity. It can arise due to weather events, natural disasters, geopolitical tensions, or other factors.
- Demand risk: This is due to changes in demand for a commodity. It can arise as a result of changes in consumer preferences, shifts in economic conditions, or changes in government policies.
- Currency risk: This is the risk of loss due to changes in exchange rates between currencies. It can affect the cost of imports or exports of commodities.
- Credit risk: This happens when a counterparty fails to fulfill its contractual obligations related to commodity transactions. It can arise due to counterparty default, insolvency, or other factors.
Other types of commodity risk
While these five types of risks are the most common risks associated with commodity trading, there can be additional risks depending on the nature of the commodity and the market in which it is traded.
- Regulatory risk: This is when changes in regulations or laws impact supply, demand, or pricing dynamics.
- Market liquidity risk: This is another potential risk, particularly in thinly traded markets, where buying or selling large volumes of commodities can lead to price volatility or difficulty in executing trades.
- Operational risk: This can happen due to technical issues, human errors, or other operational failures.
- Physical delivery risk: This is only a concern in markets where physical delivery of commodities is required, as logistics can impact delivery timelines and costs.
These risks can be managed through various strategies, including hedging, diversification, and risk transfer through insurance or other financial instruments.
However, it’s important for commodity traders and investors to carefully assess the specific risks associated with the commodities and markets in which they trade and take appropriate measures to manage those risks.
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