Risk management for commodity trading: volatility, limit moves and gaps

What you will learn

• How to calculate contract value and tick value for common commodity futures
• What daily price limits and limit-locked markets mean for your exit
• How to add a stress test for gaps and limit moves to your position sizing
• Commodity-specific risks: negative prices, delivery dates, exchange interventions and CFD leverage

Explanation

The course "Risk Management" teaches position sizing. Commodities add risks that a stop-loss alone cannot handle. Futures and CFDs are leveraged, can lose money quickly, and losses can exceed the planned risk.

Contract value and tick value

A futures contract has a fixed size. The tick is the smallest price step, and the tick value is what one tick is worth per contract.

Check current specifications on the exchange before trading; they can change.

Volatility differs and changes

Volatility varies between commodities and over time. ATR (average true range, covered in "Technical Analysis") divided by price gives a percentage you can compare across markets. Rule of thumb: when ATR in percent doubles, halve your position size.

Price limits and limit-locked markets

Some futures have daily price limits: a maximum move from the previous settlement. For CME grain futures, limits are reset twice a year, on the first trading day of May and November, based on a 45-day average price times a fixed percentage (7% for corn). If a contract settles at the limit, expanded limits about 50% higher apply the next day. When the price reaches the limit and no one trades on the other side, the market is limit-locked: your stop cannot be filled, possibly for several days. Other contracts, such as many energy futures, use short trading pauses instead of fixed limits.

Gaps and extreme events

• Report gaps: USDA crop reports and EIA inventory data (lesson 6) can move prices sharply in seconds.
• Weekend gaps: OPEC+ decisions or geopolitical news over a weekend can open the market far from Friday's close.
• Negative prices: on 20 April 2020 the May WTI contract settled at −$37.63 per barrel, according to the US Commodity Futures Trading Commission (CFTC), because holders could not take physical delivery.
• Exchange interventions: exchanges can raise margins at short notice, suspend trading or cancel trades, as the LME did with nickel in March 2022.

Delivery dates

Many commodity futures are physically delivered. Before the first notice day (the first day a seller can announce delivery), private traders usually must close or roll; brokers often close positions automatically, sometimes at a poor price.

CFDs on commodities

Under the EU retail rules (ESMA, implemented in Germany by BaFin), the maximum leverage for CFDs on commodities other than gold is 10:1, so the margin is at least 10% of position value. Commodity CFDs are often based on futures; check how your provider handles the roll.

Stress-test rule

Next to normal risk (entry minus stop), calculate a stress loss from a plausible gap or two limit-locked days. Keep it below a fixed share of the account, for example 3%; otherwise reduce size or use a smaller contract.

Worked example

Hypothetical example: account €25,000, risk per trade 1% = €250, stress limit 3% = €750. EUR/USD = 1.10. Commissions and slippage are excluded.

Trade 1: Micro WTI. Entry $70, stop $68.

1. Risk per contract: $2 × 100 barrels = $200 = $200 ÷ 1.10 = €182. One contract fits the €250 limit.
2. Stress test: a weekend gap of $6 against you: $6 × 100 = $600 = €545, or 2.2% of the account. Below 3%: acceptable.

Trade 2: Corn, one full contract. Assume a daily limit of $0.30 per bushel.

1. One limit day: $0.30 × 5,000 = $1,500.
2. Two limit-locked days: $3,000 = $3,000 ÷ 1.10 = €2,727, or 10.9% of the account.
3. Result: the stress loss is more than three times the 3% limit. Even with a tight stop, this trade is too large for this account.

Common mistake

Practice activity

Hypothetical account: €40,000, risk per trade 1%, stress limit 3%. EUR/USD = 1.10. Natural gas is at $3.00 per MMBtu. Your stop is $0.15 away. A full contract is 10,000 MMBtu; assume a smaller contract of 1,000 MMBtu is available.

Tasks: (1) Can you trade one full contract? (2) How many small contracts fit the 1% rule? (3) Run a stress test for a $0.60 gap on that position.

Limitations: Real gaps can be larger than any scenario you choose; the stress test reduces, but does not remove, the risk of large losses.

Key takeaways

• Know contract size and value per $1 move before every trade.
• Daily price limits can lock you in; expanded limits and multiple limit days are possible.
• Size for a stress scenario (gap or limit days), not only for the stop distance.
• Watch delivery dates, exchange margin changes and the 10:1 CFD leverage limit on commodities other than gold.

Next step

In lesson 13 you combine everything into a commodity watchlist and a weekly research routine.