How does commodity trading work?
Investors buy and sell commodities through either futures contracts on an exchange, or forward contracts over-the-counter. This effectively means that prices are agreed upon months in advance, and these exchanges standardise the quantity and minimum quality of the commodity. For example, the London Commodity Exchange might stipulate that 5,000 bushels comprise one wheat contract. It would also state which grades of wheat could be used to satisfy the contract. All wheat that meets that grade and criteria will be sold for the same price, regardless of where it was grown, and any slight variations in quality.
In the physical commodities market, there will be an actual exchange of goods. A breakfast cereal producer might also buy a futures contract for corn with a delivery date months in the future. This way, buying under a futures contract will protect the buyer if the future market price of corn is higher than the agreed price. The certainty that the transaction will take place allows both parties to plan and budget confidently.
Most commodity traders, however, do not take physical ownership of the goods. Commodity speculators or traders take a financial position (long or short) on a commodity. Commodities can as contracts for difference (CFDs) can be done using an online trading platform. Learn how to trade commodities.
What are the most popular commodities?
Some of the most popular commodities include crude oil, natural gas, gold and silver. Other commonly traded commodities include heating oil, sugar, corn, coffee, wheat and soybean.
The most actively traded commodities will differ depending on how the markets are performing. For instance, a highly volatile petroleum market may attract more price speculators. This increases both volume and open interest.
So, what is the most valuable commodity? Commodities with high volume are often the most popular ones to trade. Low volume commodity markets can be prone to higher volatility or even wild price swings. The topic of 'most valuable commodity' depends on many factors: the political, social and economic stability of a region and external factors such as weather conditions and natural disasters that can ruin agricultural commodity production, for example.
What is the commodity value?
News trading involves following and responding to current social, political, and economic changes. This can be beneficial to both short and long-term traders.
For example, if a report was published stating that demand for gold has hit a ten-year low, many traders would look to sell gold over fears that its value is likely to decrease. A sudden rise in the number of people selling gold could have an impact on your trades, as it would push gold prices lower and the value of gold would increase.
High impact news bulletins can have an impact on the commodities market and the value of certain commodities. By understanding how to take advantage of these events, you may be able to increase your profitability.
Commodity price trends
Most commodity traders incorporate technical analysis into their trading plan. Technical analysis involves utilising previous price movement data to estimate future price movements.
Those traders just starting out would benefit from learning how to read charts. A basic understanding of charts could help you anticipate a potential market move. A starting point would be to look at the price chart of a market you are interested in trading.
Trading the trend is one of the golden rules of trading. For instance, basic technical analysis suggests that the ideal time to buy an up-trending commodity is when it is breaking out to new highs. However, technical analysis does not guarantee results of course.
Many commodity traders take news releases and economic events into account in order to build an event-driven trading strategy. They will constantly monitor and analyse the factors that are likely to affect the relevant commodities market, hoping to benefit from any changes in price movements.
Advantages of commodity markets
Diversification: Commodities provide the opportunity to diversify your existing trading or investment portfolio. Trading in commodity markets can also provide a greater deal of diversification in comparison to other securities, as they often have a low or negative correlation when compared to other major asset classes.
Inflation: Inflation can cause currencies to depreciate, which can lower the value of many financial assets such as stocks and bonds. However, commodities tend to hold their relative value during periods of high inflation, hence why many investors turn to precious metals such as the ‘safe haven’ of gold in uncertain times.
Liquidity: The commodity market is generally known as a highly liquid market when compared to real estate or penny stocks. This is especially the case when popular commodities such as gold, oil or natural gas are in question.
Volatility: Volatility in a commodity market can be perceived as both an advantage and a risk. It can be an advantage if you are able to predict when there will a jump in a commodity’s price, for example, if there is war in a major oil producing country such as Iraq. Smart investors can quickly realise the macro forces that could impact the specific commodity markets, and can capitalise on these forces.
Risks of commodity markets
Value of commodities: Although rare, when trading commodities, you undergo the risk of a more efficient process or relevant product being invented that can largely devalue some commodity markets. An example of this was in the 1980s, when massive amounts of silver was consumed as part of silver-based imaging in photography films. However, due to the rise of digital cameras without the need for films, the demand for silver dropped for this use, causing the overall demand and thus the price of silver to fall.
Demand: Demand within commodity markets presents a major risk for commodity traders. The value of gold, oil and other commodities are difficult to predict, and an incorrect speculation on your behalf can result in a losing trade.
Volatility: A double-edged sword, volatile markets can present a commodity trader with great opportunities for both profit and loss.
Alternatives to commodity trading
There are a number of potential alternatives to commodity trading.
Forex (or currency trading) is the world’s most traded market, and is built around buying one currency in exchange for another. Economic and political factors play a part here, making it an exciting market to trade. The forex market has no physical location, and is open to trade 24 hours a day from Sunday night to Friday night.
You can also trade on indices like the ASX 200, UK 100, Germany 40, and US 30. Indices gauge the value of a section of the stock market, and are calculated from the combined prices of selected stocks.
Another alternative is to trade on shares, popular stocks include Apple, BP and Lloyds Banking Group.
The treasuries market can also be traded. Examples of treasuries include government debt instruments such as gilts, government bonds, and treasury notes.
It is generally recommended that you diversify your portfolio. Avoid putting all your eggs in one basket - or a single trade. Does a market have sufficient liquidity and interest? Do some research before taking the plunge and trading or investing in a particular market. Successful traders tend to follow a strict trading discipline. Research, a solid trading strategy and sound money and risk management skills are key.
Commodity demo account
You can trade commodities through a commodity broker by setting up an online account. Futures contracts provide the most direct way to invest, as these set an obligation to buy or sell a commodity at a fixed price and date. Buying into a commodity futures contract lets investors lock in quantity and price, thus minimising volatility.
Commodities are also available to trade as CFDs. With CFD trading, you don’t take ownership of the underlying asset. Instead, you speculate on whether the price of the commodity you are trading will go up or down, and open a position accordingly. CFDs are leveraged products, which gives you a greater amount of exposure to the market. Thus, while it is possible to maximise profits via a larger deposit, losses will also be magnified. Compare our award-winning Next Generation platform features to MetaTrader 4: choose the best trading platform for you and tailor it for your individual trading needs: Next Generation vs MetaTrader 4
