Commodities Trading: The complete guide

A commodity is a fundamental item or raw resource that is used to make other items. Commodities are used to develop things we depend on every day. Assets like oil, gold, copper, wood, iron and silver may be used as examples of commodities.

Commodities are standardised and interchangeable in order to isolate them from other things. No matter where the commodity is manufactured, two equal units will be more or less same.

Commodity trading 

Speculators should consider in trading commodities elements such as trade-related volatility levels, the aforementioned market fluidity and other variables that affect price movements as described below.

Commodity trading now takes place on global platforms such as the London Metal Exchange (LME) and the Chicago Mercantile Exchange (CME). To trade commodities, you must first open an account with a trading platform that provides access to commodity markets.

Commodity trading types:

Futures:

The initial objective of a futures contract was to safeguard producers from abrupt price changes. With the passing of generations, the future has become a successful manner of trading in goods. In essence, a future contract is an agreement to acquire or sell a good on a certain price and date. The goods shall be paid and/or delivered on the date indicated in the contract.

Contract for Difference (CFD): 

A Contract for Difference is an agreement that determines the difference between the starting price and the closing price of the asset to conclude the profit or loss agreement. With respect to CFDs, a settlement of profit or loss should be done by cash instead of physical delivery. CFDs give traders a  great means of access to goods without the asset they hold. CFD’s have become popular because they enable traders to earn money using leverages, a strong instrument in the very liquid commodity market, via rising and falling prices.

Indirect investment:

The purchase of inventories and mutual funds or ETFs that are regarded as indirect investment is another option for investors to obtain exposure to commodities. It should nevertheless be borne in mind that equities and mutual funds are entirely separate asset classes, which are not necessarily impacted by forces dictating the commodities markets.

Options: 

On commodities, options trading occurs in the form of call and put options. You purchase the right to buy and sell a certain underlying asset at a defined price within a certain time period. Call options enable you to purchase a commodity, while put options enable you to sell it.

Stocks:

Stocks trading is a popular technique of trading in the sector. It enables you to invest in the stock of any firm that possesses commodities. You will then wait for the prices to appreciate in order to profitably sell the shares.

Why trade commodities?

Commodity trading has many benefits. Here are some of the primary benefits:

Lots of trading chances: Since commodity prices are fluctuating, traders have an edge because there are always plenty of trading chances. Traders may also trade in both directions, which means they may profit from both upward and negative market fluctuations.

Leverage may increase profits: When trading commodities, you may use ‘leverage’ to control a huge amount of money with a little investment. This is advantageous since it has the ability to multiply your benefits. However, leverage may also raise your losses, so it is important to be aware of the hazards. 

Commodity markets are operating around the clock for most of the week. This means you may trade on your own time.

Commodities have minimal correlations to conventional asset classes such as equities and bonds, which allows for portfolio diversification. Gold, for example, which is seen as a “safe-haven” asset, often appreciates during moments of economic uncertainty while equities plummet. This implies that commodities may assist traders and investors diversify their portfolios while also possibly lowering total portfolio risk.

A hedge against inflation: Inflation causes conventional currencies to lose buying value over time (the increases in the prices of goods and services over time). Because commodity prices frequently increase during times of high inflation, commodities may shield investors against inflation.

How to trade commodities CFDs?

CFDs are one of the simplest and most popular ways to trade commodities. A contract for difference (CFD) is an agreement between a trader and a broker to profit from the price difference between opening and closing a trade.

Investing in commodity CFDs eliminates the cost of commodity storage in the event of physical delivery. Trading commodities with CFDs allows you to go long or short without having to deal with traditional commodities exchanges such as CME or NYMEX.

CFDs also give you the option of trading commodities in both directions. You can try to profit from either upward or downward future price movements, regardless of whether your commodity price forecast is positive or negative.

Furthermore, commodity trading via CFDs is frequently commission-free, with brokers profiting from the spread – and traders profiting from the overall price change.

Another advantage is that CFDs are leveraged products.This means that a small amount of capital is required to open a position and gain exposure to a much larger sum of money in the trade. This results in an amplification of profits and losses, as they are determined by the total trade value.

Types of commodities 

Commodities can generally be divided into three main categories: metals, energy, and agricultural. Here’s a look at each of these categories. 

Metals

Gold, silver, platinum, and copper are all examples of metals. Some investors may choose to invest in precious metals, particularly gold, during moments of market turbulence or bear markets since it is a dependable, predictable metal with actual, transferable worth. Investing in precious metals can also be used as a hedge against high inflation or currency depreciation.

Energy

Crude oil, heating oil, natural gas, and gasoline are just a few of the energy commodities available. That demand for energy-related items has increased at the same time as oil supplies have diminished, global economic changes and decreasing oil outputs from established oil wells around the world have historically contributed to rising oil prices.

Agricultural 

Agricultural commodities include crops and animals that are grown or farmed on farms or plantations. Grain, livestock, sugar, cotton, cooa, wheat and dairy products are common agricultural commodities that supply nourishment for people and animals all over the world.

Hard vs soft commodities 

Coffee, cocoa, sugar, corn, wheat, soybeans, fruit, and cattle are examples of soft commodities. Commodities that are farmed rather than mined are referred to as soft commodities; the latter (such as oil, copper, and gold) are referred to as hard commodities.

What drives commodity prices? 

Each commodity’s price is influenced by specific factors.

Overall, supply and demand are the most important factors influencing commodity pricing. A commodity’s price rises in response to increased demand, whereas its price falls in response to excess supply.

Many diverse factors have an impact on supply and demand. Here are some of the most important elements to consider.

Demand 

The worldwide travel industry came to a halt in early 2020 when the Covid-19 epidemic pushed the world into lockdown mode. As a result, demand for oil, which is used in gasoline and aviation fuel, fell dramatically. As a result, the price of oil plummeted dramatically.

Key drivers of commodity demand include: 

  • The state of the global economy: demand for numerous commodities tends to be high during periods of strong economic expansion due to increased construction and manufacturing activities. Commodity demand, on the other hand, tends to be lower during periods of sluggish economic growth since construction and manufacturing activity are reduced.
  • Emerging market countries like China and India are a big source of commodity demand. Commodities are needed to create infrastructure, fuel factories, and feed rising populations in these countries. Commodity demand tends to be high during periods of economic expansion in emerging markets.
  • Consumer trends are equally important in commodity demand. Demand for jewelry, for example, might increase gold demand. Similarly, demand for automobiles can affect demand for platinum, which is needed to create catalytic converters, which help reduce vehicle emissions.
  • Commodity substitution can have a detrimental effect on demand in the manufacturing industry. Buyers will seek cheaper alternatives if a certain commodity becomes too pricey. Copper, which is used in a wide range of industrial applications, is a suitable example. As copper prices have grown, several businesses have switched to aluminum as a substitute.
  • The US dollar’s strength: most goods are priced in US dollars. When the value of the US dollar decreases, commodities become less expensive in other currencies, increasing demand. When the value of the US dollar has deteriorated versus other major currencies in the past, commodity prices have tended to climb. However, this inverse association isn’t always true.

Supply 

Saudi Arabia’s Saudi Aramco oil processing facilities were attacked by a swarm of explosive drones on September 14, 2019. The drone strike resulted in huge fires at the facilities, momentarily reducing Saudi Arabia’s oil production by roughly half – around 5% of global oil production. Oil prices rose sharply as a result of the sudden decline in supply.

Commodity supply is influenced by a number of factors, including:

  • Government intervention: By imposing production limits, governments can play an important role in commodity supply. For example, the Organization of Petroleum Exporting Countries (OPEC), an intergovernmental oil organization, has been known to impose supply cuts on the oil market to prop up prices.
  • Conflicts between countries, terrorist attacks, trade wars, societal unrest, and the closure of vital transportation routes are all examples of geopolitical events that might affect commodity supply.
  • Weather: The supply of agricultural commodities such as sugar, cotton, and cocoa can all be affected by the weather. Farmers need constant weather cycles to cultivate crops in these types of commodities.

Risk management strategies 

When trading commodities, you can never totally eliminate risk; nevertheless, you may lessen it by focusing on risk management.

The following are three risk-reduction strategies:

  • Choosing the right position size for each trade: Before you start trading commodities, you need to decide on the best position size for each trade. A decent rule of thumb is to never put more than 5% of your capital at danger in a single deal. Trading more than 5% per trade could result in losses that are difficult to recover from.
  • Using stop losses: Stop losses are an important part of any sound risk management approach. Stop losses are used to limit trading losses by closing out lost positions before they become too large.
  • Diversifying your portfolio: A portfolio that monitors a diverse mix of assets will be less risky than one that concentrates solely on one item. You can reduce your overall portfolio risk by diversifying your portfolio over several asset classes such as stocks, ETFs, cryptocurrencies and commodities.

Best commodities trading platforms

Trading Platform Fees Leverage Review Promotion Website
1xtb review Zero commission*
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Summary

Both novice and experienced traders have a variety of options for investing in financial instruments that provide access to commodity markets. While commodity futures contracts are the most direct way to participate in the price movements of the industry, there are other types of investments with lower risk that also provide adequate opportunities for commodities exposure.

Commodities are known to be risky investment propositions because they can be affected by uncertainties that are difficult, if not impossible, to predict, such as unusual weather patterns, epidemics, and natural and man-made disasters.

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