Commodities trading, like any other commodity trading, utilize a principle called “leverage” to expand the reach of the investor. Much like mechanical leverage in your old physics class, financial leverage is about multiplying the amount of motion you get from the energy you put into a transaction.
How it works is like this: Instead of ponying up $10,000 of your own money to make a commodities trade, you put up about $500 (1/20th of the amount purchased), and borrow the remaining $9,500. Let’s say that your trade shifts by 10 basis points between the price you purchased the commodity at and the price you sold it at; you’ve made a $10,000 purchase and sold it for $10,100, making a $100 profit on the transaction.
Now, you will have to pay back the $9,500 you made, plus some interest on the loan. Let’s assume that the interest is 9% per year, and that you made the margin purchase and sale in a 24-hour period. If you held on to the $9,500 for an entire year, you would have to pay $855 in interest. Since you only held on to it for one day, you pay $855/365=$2.35 in interest on it.