Commodity Trading - the Game of High Risk, High Return

by : sanjay jha

Commodities trading has become popular in recent times. This once obsure sector of trading now attracts financial trading banks and hedge funds whereas once upon a time only those with deep knowledge of physical commodities markets would dare to enter.

The new entrants into the market are there for one reason only. They can see an opportunity to make great returns but their presence in the markets bring changes for the more traditional commodity trader. The key to understanding the new market dynamic is that sophisticated traders understand commodity risk management. With superior knowledge, trading techniques and the right trading and risk management software, they are equally able to make profits in a falling or rising market.

At first it might seem a little shocking to realise that household names in investment banking are now moving cargos and consignments around the world. This is not some virtual reality game but real physical oil and real gas pipelines. There was a time when bankers would shy away from the idea an oil tanker being delivered to some guys in Wall Steet. It seems almost ludicrous but the world of commodities trading is changing and this is now the new reality.

There are however, some deep rumblings of disquiet in some circles. Whilst traders can make great profits in commodities trading, risk managers and senior executives would be wise to take note. The risks associated with physical commodities adds a new level of complexity. Banking software for trading and risk management is not designed to cope. And so the banks have gone out and purchased energy trading and risk management software specifically for the job.

The problems start to become apparent when you consider the complexity of trying to integrate say, an energy trading and risk management software with the banks existing financial risk management software. The designs do not work well together and can easily create mismatches. Trying to tie together systems that were never designed to talk to each other can create a tangled web that is fragile and fragmented.

In the race to get to market early the tempation is always there to cut a few corners. Rather than spend time designing and architecting robustness into the overall eneterprise solution, the pressure is on to deliver a working solution quickly but this can lead to flaws in the design, which is where the danger lies. Hidden deep within the cyber world lies the possibility of hidden errors with the potential to accumulate over time and create substantial losses. The operational risk embedded within energy trading systems landscapes can be the silent killer.

How can such risks be avoided? Firstly, trading firms need to recognise that spending money and effort to create robust reliable enterprise systems is money well spent if it avoids the potential of catastrophic operational losses. But it is not just a question of money. With the right technology it is possible to deliver working solutions quickly without compromising on good architecure and best practice. Fully functional light-weight framworks for risk management are available from Hyper Rig for example, that ensure firms can reduce time to market and still have reliable, integrated trading and risk management software across all asset classes.