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, which you can trade via a spread betting or CFD trading account. Continue reading to find out more about commodity trading.

Commodity definition

The debate of commodity vs product relates to the beginning and end of the production process. A commodity is a raw material that is used in the manufacturing of commercial goods, and the product refers to the physical goods as a result.

Each commodity comes with a commodity code: a 10-digit number that helps to identify import and export restrictions from outside the EU. This includes duty and VAT ratings that you may be charged and import licenses that you may have to declare when introducing a commodity to customs.

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. 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).

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:

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.

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.

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Commodity value

The 'commodity value' represents the intrinsic value of a particular asset within its market, which is reflected by its price. This can change depending on market changes and updates. News trading involves following and responding to current social, political, and economic changes, which 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. Read about how to invest in gold to understand the best strategies, indicators and methods of technical analysis for the commodity market.

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. These traders just starting out would benefit from learning how to read trading 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.

What is a commodity trader?

A commodity trader is involved in the trading of commodities. Examples of assets that commodity traders deal with include popular raw materials such as precious metals, energies and agricultural products. The daily trading efforts of commodity traders are often driven by a mix of fundamental and technical analysis. Traders stay up to date with the news on commodities to ensure they are aware of the macro-environmental forces that drive their prices, and then utilise technical analysis to make entry and exit trading decisions based on past trends.

Types of commodity traders

Commodity traders can be split into many categories, dependent on the asset that they trade. Some deal with hard commodities while others trade soft commodities; some traders prefer to focus specifically on the agricultural industry while others invest in gold to hedge their risk against stock market downturns.

Agricultural traders

An agricultural trader is a type of trader who deals with agricultural assets. Agricultural commodities are staple products and often provide a source of food for the global market. These include grains, livestock and dairy products. However, agricultural traders also get involved with the trading of non-food related agricultural commodities.

Agricultural trading is characterised by a dynamic market that is often influenced by a number of factors, including population growth, global demand, global warming and technology. However, the markets are generally expected to rise given the growing number of people and the rising wealth of consumers in growth markets.

Gold traders

Gold is the most popular asset among the precious metals. It is traditionally known as a safe investment and is often bought by governments, banks, hedge funds and traders. A gold trader can invest in the gold market for several reasons, one of them being to increase an investor’s balanced portfolio.

Many traders use gold to diversify their portfolio risk. They can achieve this by purchasing gold to hedge against stock market risks, such as global inflation or political instability. This is because unlike fiat currencies, gold often maintains its purchasing power in periods of prolonged inflation or market instability.

Oil traders

An oil trader is involved in the trading of various types of oil. The oil is named depending on where it is produced. WTI (West Texas Intermediate) oil is produced in the USA, whereas Brent Crude Oil is produced in the North Sea.

Oil is one of the most popular commodities to trade as it is extremely liquid and heavily relied upon worldwide. The price of oil is not just influenced by supply from oil producing companies; it is also influenced by global demand, green initiatives, political situations and organisations such as OPEC (Organisation of Petroleum Exporting). Read more about crude oil spread betting and oil CFDs.

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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 trading (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.

Commodity trading accounts

At CMC Markets, we offer a variety of leveraged trading accounts that can be used to trade on commodity markets. You can open either a spread betting or CFD trading account. Both of which are similar in their function but have some unique features.

Spread betting commodities

Commodity traders can open a spread betting account to trade on price movements in commodity markets. Spread betting is a tax-efficient* method of trading as it’s free from capital gains tax and stamp duty. Please note that spread betting is only available to customers who reside in the UK or Ireland.

CFD trading commodities

CFD trading is available globally, so traders can speculate on commodity markets wherever they reside. When trading CFDs you have to pay capital gains tax, but trades are exempt from stamp duty. However, unlike spread betting when trading CFDs you can offset profits against losses for tax purposes.

Commodity demo account

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. A commodity demo trading account is an effective way to trade the markets risk-free with £10,000 worth of virtual funds, so you can practise your trading strategies before opening an account with real money.

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Summary

Commodity markets offer a good opportunity to diversify your trading or investment portfolio. You can trade on commodity market price movements with a live trading account. However, for new traders, it is recommended to design an effective trading strategy in which to direct your commodity trading efforts. Once you have a coherent trading strategy, you can practise trading on a demo account in a risk-free environment with $10,000 of virtual funds. Read our article on how to trade commodities for more information on how to succeed within commodity markets.

*Tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.

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. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.