What is a commodity?
A commodity is a physical good that can be bought or sold on the commodity market. Commodities can be categorised into either hard or soft varieties. Hard commodities are natural resources like oil, gold and rubber and are often mined or extracted. Soft commodities are agricultural products such as coffee, wheat or corn.
The most widely traded examples of commodities have well-established markets, with around 50 major commodity exchanges globally. Crude oil is the most widely traded commodity in the world.
How does commodities trading work?
Investors buy and sell commodities through futures contracts on an exchange. 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. This can be done using an online trading platform. Commodities can also be traded as spread bets (UK and Ireland only) or contracts for difference (CFDs).
Most popular commodities to trade
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:
- Volume relates to the total number of contracts that are being traded.
- Open interest is the total number of open long and short positions in a market.
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.
How to trade commodities
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 spread bet or trade as CFDs. With spread betting and 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. Spread bets and 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.
Many trading platforms offer demo accounts, which provide traders with an excellent environment in which to practise their trading techniques. You can familiarise yourself with placing orders, for example.
News trading
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.
High impact news bulletins can have an impact on the commodities market. By understanding how to take advantage of these events, you may be able to increase your profitability.
Many commodity traders take news and economic events into account when planning their trading strategy. They will constantly monitor and analyse the factors which are likely to affect the relevant commodities market, hoping to benefit from any changes in price movements.
Technical analysis
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.
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 UK 100, Germany 30, 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.
Disclaimer
CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.
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