Commodities Trading Explained
Commodities Trading Explained — How To Use CFDs to Trade Commodities
The commodities are raw materials or basic goods and, just like anything else of such value, we can trade them. Sorted into a few categories, commodities can be a vital trading asset, mainly because they can diversify the trader’s portfolio. Commodity trading includes trading (selling and buying) of basic goods and raw materials, including gold, oil, coffee, etc.
Because commodity trading is one of the oldest (if not the oldest) forms of trading, every trader dabbles in it sooner or later. However, the supply and demand of commodities aren’t easy to predict, which is why they can be risky investments. Some factors that contribute to market and price movements (such as global pandemics or natural disasters) aren’t as easy to anticipate, which is why the risk is higher than with, say, currency exchange.
Of course, not all commodities are traded as much as some others, nor do they play an equally significant role in the global trading market. The most commonly traded commodities are gold, silver, and oil. Aside from those, several more contribute to the worldwide market in a significant way.
Corn, wheat, cocoa, rice, coffee, soybeans, sugar, and cotton are agricultural commodities. All of these are weather-sensitive which means they are volatile during weather transitions.
Coffee continues to be a growing market and an exciting investment opportunity given that the supply is limited to a handful of countries. The situation is similar to sugar. However, coffee as a commodity hasn’t seen as much government interference as sugar, making it a less risky investment. Some factors make sugar a difficult trading commodity.
Wheat as a trading commodity is a rising opportunity. The speculations are that the market will continue to grow, partially due to the increasing demand for nutritious food sources that are affordable.
Corn is a hot commodity because, aside from being a food source, it’s also the primary substitute for sugar when it comes to the production of specific foods. However, corn is also one of the main ingredients in ethanol fuel. Given that fuel and food are unlikely to out of demand, corn is a stable trading opportunity.
Soybeans have a critical role in the production of biofuel and food, as well as in the production of food for livestock. That makes it a continually growing market.
Energy commodities include gasoline, crude oil, and natural gas. When it comes to the impact on the global market, energy commodities, especially crude oil, have the most significant one. That’s why they are so popular among traders. Their prices are also somewhat easier to predict, considering that world events and political movements are some of the factors affecting them.
Whether you’re a beginner trader or a veteran, liquidity is something to pay close attention to when trading commodities. Crude oil, which has two different markets (West Texas Intermediate (WTI) and Brent Crude), is the most liquid commodity market. Natural gas comes as a close second. Gasoline is also high up on that list.
However, considering gasoline has an inelastic demand (in other words, no matter the price, people will still buy it), it has a considerable effect on the global economy.
Metals and Precious Metals
Gold, copper, and silver are also high on the list of most commonly traded commodities (right after the energy commodities and soybean and corn). However, they are also fan-favorites because traders love precious metals and trade them to diversify their portfolios.
Gold is an excellent alternative to paper money which is why people most commonly trade with it. However, it’s easily affected by inflation.
Still, precious metals are safe havens for trading. They’ll most likely keep their value or even increase in value over time. So, they’re a good investment. During times of volatility, precious metal trading is one of the best moves a trader can make.
What Is Commodity Trading?
As mentioned, commodities are essential goods. These basic goods play a significant role in the daily lives of the entire world, which is why they are vital for our survival. That’s not a new development, considering that people traded commodities in ancient times. And they still do now!
Commodity trading involves an exchange of assets. These asset exchanges are regulated by contracts (usually futures contracts) and are based on a commodity’s price (typically a physical commodity, underlined). Investors buy or sell contracts and essentially bet (guess or speculate) on the future value of that commodity. So, based on their opinion on the future movement of prices of specific commodities, they either sell contracts (go short) or buy them (go long).
Commodities are interchangeable. They are the same no matter where you’re getting them from. So, technically, you can combine your commodity of choice without affecting its quality (get some from multiple manufacturers or producers and maintain the same quality).
Why is that important? Because trading commodities can happen in several different ways.
Types of Commodity Trading
Futures contracts— one of the most common ways to trade commodities is with futures contracts. Future trading means that two parties are signing a legally binding contract stating the amount of a specific commodity that can be bought at one particular time and at what price. So, the buyer is promising to buy that specific amount, and the seller is promising that they’ll sell (provide and deliver) the specific amount of commodity before the contract expires.
Stock trading— stocks related to commodities are another option when it comes to trading commodities. Rather than going for the commodity itself, some traders prefer to invest and trade with stocks of companies that deal directly with commodities.
Mutual fundsexchange-traded funds (ETFs), and Exchange-traded notes (ETNs) — these trade like stocks, and they don’t have the same binding obligation as futures contracts. All these types of funds combine the investment money of several (or many) different investors to get a more extensive portfolio than they could on their own. These funds can combine various commodities and buy futures contracts. That way, they’re trying to track the price of that specific commodity (or multiple commodities), or they can invest in the stock of commodity-related companies. These funds are a great way to get into the commodity trading market because they don’t require a significant investment fund of your own.
The History of the Commodity Market
Trading commodities has been the rise and fall of many empires throughout the centuries. And, even though the global economy evolved and trading now looks a bit different than it did in Ancient Sumeria, commodity trading is still a considerable part of the trading market. What’s more, it still shapes the global economy.
Modernized commodity exchange markets started appearing in Europe in the 10th and 11th centuries. The actual modern commodity exchange markets that resemble the one we have today are somewhat of a modern invention, the first one being the Chicago Board of Trade which opened back in 1864.
What Drives the Commodity Market?
The commodity market is highly volatile. Supply and demand are the most significant factors that drive the commodity market. When there’s a lack of supply and the demand increases, the price of the commodity in question goes up. Likewise, if there’s no demand and the supply is high, the prices will go down.
So, if there’s a disruption in the supply of a specific commodity, we can expect that the demand will rise and the price will go up. Then we can make trading decisions and moves accordingly.
But it’s not just the supply and demand that determine the commodity price.
Major factors also include:
- Currency movements
- Economic growth
- Geopolitical situations
- Government policies
Commodity prices are typically reflected in US dollars. Any change in the value of the US dollar also affects the prices of commodities. If the US dollar skyrockets compared to other currencies, the commodities such as crude oil and other energy commodities will fall.
Geopolitical situations and government policies can also affect the price, especially when it comes to commodities that are produced only in specific regions or countries (such as coffee).
How Does CFD Trading on Commodities work?
CFDs are contracts for differences. These are somewhat standard contracts stating that a difference in the price between the open and closing trades will be paid in cash.That means that no physical goods are actually exchanged or delivered. Only the price difference is paid.
CFDs are very popular in commodity trading. But how do they work?
Because you can trade on margin and with high leverage, you only need to deposit a fraction of your trade’s total value to trade with commodities CFDs. That’s what puts CFDs head and shoulders above futures contracts for some traders.
Furthermore, with CFDs, you can profit from all price movements.
The Six Steps of Commodity Trading
step one is to pick your market.
See what your broker is offering and select a commodity you want to trade with.
are you going short or long?
In other words, what do you think will the price go up, in which case you should buy, or down, in which case you should sell?
next, decide how many units you want to trade. Keep in mind that CFDs vary in terms of value (depending on which instrument you chose).
the fourth step is utilizing risk management tools. Stop-Loss (Close at loss) and Stop Limit (Close at profit) are some of the most popular options.
it’s vital that you keep an eye on the position and monitor the real-time profit (or loss).
close the trade when you think it’s the right time.
Traders can trade with lots of commodities, given that each of the main categories has quite a few essential goods and raw materials. However, that’s only in theory. In practice, commodity availability depends on the broker you choose. You might be interested in trading with a specific commodity. However, if your preferred broker doesn’t offer that option, you’re out of luck.
That’s why it’s crucial to pick the right broker for your needs. When it comes to brokers, only some make the coveted list of best CFD brokers.
What Is Spot Trading?
With brokers, you can also partake in spot trading. With spot trading, you’re exchanging a commodity for a major currency. There’s a significant difference between spot and futures trading. With futures contracts, there’s a delay in payment and a set date for delivery of the goods. With spot trading, there’s an immediate buying of selling.
Thus, there’s also a difference between the spot price and the futures price. The spot price is a quote for an immediate transaction. In contrast, the futures price is an offer for a transaction that will happen under certain terms (a specific amount of commodities will be delivered and paid for at a specific time).
Benefits of Commodity Trading
Other Ways to Invest in Commodities
- ETFs and ETNs
- mutual and index funds
- commodity pools and managed futures