Commodity trading has been an ancient practice that has evolved over the ages. There is a wide range of commodities today where modern-day trading takes place on exchanges like the Chicago Mercantile Exchange and the London metal exchange. As with trading commodities, one needs an account on a trading platform to be able to trade in the commodity market. In this guide, we will dwell on the following themes.
- What are Commodities?
- Why Trade Commodities
- Types of Commodities
- What drives Commodity Prices?
- Trading Commodities with CFDs
- Commodity Trading Risks
What are Commodities?
A commodity is an initial good or raw material that is used to manufacture more complex goods. You can think of raw materials as the building slabs of the global economy, they are used to produce products that we use every day. Examples of such raw materials include oil, copper, copper, and sugar. What separates commodities from other commodities is the fact that they are standardised and exchangeable. This means that 2 equivalent units of the same product will be more or less equal, no matter where they are formed. For example, one kilo of gold from a mine in Brazil will be equal to one kilo of gold from Australia.
What Commodity Trading is: Like stock trading, where one buys and sells shares of certain corporations, in commodity trading, you can buy and sell commodity products. Commodities are exchanged on certain exchanges, and dealers aim to profit off the changes in the market by buying and selling these commodities. Commodity trading for novices can be made relatively easy with Contracts for Difference (CFDs) which is one of the most direct trading choices in commodities. CFDs are essentially financial instruments that provide you a chance to capitalise on price movements without the proprietorship accountability of the underlying security.
Why Trade Commodities
There are several benefits to commodity trading. Here are some of the core advantages:
Portfolio diversification: commodities incline to have low links to traditional asset classes such as stocks and bonds. For example, gold, which is understood as a ‘safe-haven’ asset, regularly rises during times of economic indecision when stocks are dropping. This means that commodities can add more varieties to a portfolio and possibly assist traders and investors reduce their general portfolio risk.
Hedging against inflation: In the end, fiat currencies tend to drop their purchasing power due to deflation (the upsurges in the prices of commodities and services over time). Commodity trading can guard investors against deflation because product prices often rise during times of high inflation.
More trading opportunities: product prices incline to be quite unpredictable, which is a gain for traders as that means there, are always enough trading opportunities. Traders can transact in both directions too, therefore, it is possible to utilise both upward price actions and downward price actions.
Trade with leverage: when trading commodities it is possible to use leverage to control a huge amount of cash with just a slight pledge of funds. This is a gain because it can amplify your gains. On the downside, nonetheless, leverage can likewise escalate your losses, so it is important to be conscious of the risks. Some agents offer leverage of almost x10 (that means you can trade $1,000 with an equity of $100) on most commodities and almost x20 on gold.
Around the time trading: commodity trading marketplaces are open for a great part of the week. This means you can trade on your timetable.
Types of Commodities
Commodities are often categorised as both ‘hard’ and ‘soft’ commodities.
Hard commodities are normally natural possessions that are mined or dug out of the ground. Examples include copper, gold, and oil. They are among the possessions that offer good spreads.
Soft commodities are naturally agricultural produce or livestock that are reared, grown, or raised on a farmstead. Examples include sugar, cotton, and wheat. The two are additionally categorised into sub-units.
There are three main categories of commodities namely agricultural, metal and energy. We will talk about them shortly.
Agricultural commodities are crops and animals that are raised on farmland. Most farming commodities are used to yield food; however, some have manufacturing uses. Examples of agricultural commodities include Sugar, Cotton, Wheat, and Cocoa.
Energy commodities play a crucial part in keeping the worldwide economy ticking over. Without energy, we would be incapable to transport persons and possessions across the sphere, power factories, or warming our homes. Examples of energy commodities include Natural Gas and Oil.
Metal commodities normally have industrial usage or are used for construction. Some metals, like gold or silver, are also used in jewelry and for venture purposes. Examples of metal wares include Gold, Platinum, Silver, Copper, Nickel, Palladium, and Aluminum. You can read further on how to trade metals in our upcoming posts.
What drives Commodity Prices?
As is with trading forex, with trading commodities, the main driver of product value is supply and demand. However, every product has unique features that affect its price. Greater demand for a product drives its prices up, while the extra supply of a commodity drives its price down. Supply and demand can be impacted by numerous factors. Here is a look at various factors.
Supply: the crucial drivers of commodity trading supply include:
Government intervention: governments play a key part in service supply by incorporating production constraints. For example, the Association of the Petroleum Exporting Countries (OPEC), the intergovernmental oil organisation, is known to enforce supply limits in the oil market to strengthen oil prices.
Geopolitical events: clashes between nations, terrorist attacks, social unrest, trade wars, and closures of important passage routes can all influence commodity supply.
Weather: the weather can also be a major role in the supply of agricultural commodities like sugar, cotton, or cocoa. These commodities require consistent weather patterns for farmers to produce crops.
Commodity supply example, in September 2019, a swarm of fiery drones bombarded Saudi Arabia’s Saudi Aramco oil-producing facilities. The drone attack triggered huge fires at the facilities that ultimately reduced Saudi Arabia’s oil manufacture by almost half – signifying about 5% of universal oil production – temporarily. This sudden decline in oil supply triggered oil prices to surge higher.
Demand: the key catalysts of commodity trading demand are:
The global economy health: during periods of robust economic progress, demand for various commodities inclines to be high owing to the fact there are extra construction and manufacturing activities. Equally, during times of feeble economic growth, commodity trading demand seems to be lower due to less construction and manufacturing action.
Growth-emerging markets: fast-growing evolving market nations such as China and India are a key source of commodity demand. These countries require commodities to build infrastructure, fuel the factories, and feed the growing populations. During times of economic growth in the developing markets, demand for supplies tends to be high.
Consumer trends: consumer tendencies also play an important part in commodity trading demand. For example, customer demand for jewellery can increase demand for gold. Likewise, demand for cars can lead to an impact on the demand for platinum, since it is used to produce catalytic converters, which aid to reduce vehicle emissions.
Manufacturing tendencies: demand can be impacted adversely by commodity switches. If a particular commodity trading turns out to be too expensive, consumers will look for low-cost alternatives. A good example is copper that is used in a wider range of industrial applications. As the rate of copper has risen, many manufacturers have to use aluminum as an alternative.
The US dollar strength: most commodities are priced in USD. When the US dollar drops, the commodities are less costly in other currencies which can trigger an increase in demand. Traditionally, the value of commodities has inclined to rise when the price of the US dollar has declined against other key currencies. This inverse connection does not hold entirely all the time.
Commodity trading demand- example: When the Covid-19 pandemic led the world into lockdown way early in 2020, the global transport industry was crushed to a halt. As a consequence, oil demand – a vital ingredient in gas and flight fuel – plummeted. This resulted in an enormous downfall in the oil price.
Trading Commodities with CFDs
The commodity trading marketplace is one of the earliest financial markets. Nevertheless, there are numeral ways to trade commodities. Today, traders have the alternative of trading commodities on the futures market or through derivatives like Contracts for Difference (CFDs). Trading commodities through a CFD service has numerous unique structures. These include lesser capital necessities than dealing with futures and trading on both growing and dropping markets. Below, you will learn the basics of trading commodities with CFDs.
CFDs are considered as an effective way to trade known commodities – such as Oil, Gold, Natural Gas, or Silver- owing to their high leverage that enables an investor to use less money to gain bigger exposure to a fundamental instrument, the growing potential for losses or profits. CFDs are derived products that allow traders to speculate on the price actions of the underlying mechanism without taking real ownership of the commodity itself.
CFDs let you transact on margin. This means you are simply required to provide a fraction of the total cost of a trade. In other words, you have the alternative to allot considerably less capital when trading in CFDs, unlike futures contracts. In addition, CFDs give an up-front way to possibly profit from mutually rising and falling markets. For example, a merchant can still gain from a dropping market by creating a ‘Sell’ (or short) position, implying that they have the intention to sell high and purchase back low. The return will be the variance between the retailing price and the buying price.
Today, it is probable for the typical retail trader to transact in a variety of assets with CFDs. Many dealers provide customers with a comprehensible trading podium where they can transact CFDs over commodities such as Gasoline, Gold, Oil, Brent Oil, Wheat, Soybeans, Palladium, Natural Gas, and more. You can perform a real-price transaction using a demo account with only a few clicks – straightforward from your devices such as desktop, mobile, and tablet. That is how practical commodity trading has become.
Below is how commodity trading with CFDs works:
You choose the product you wish to trade. i.e. oil.
You customise the CFD trade by choosing: buy or sell.
You then select but if you trust the product’s price is going to increase. It is called ‘going long.’ You can select sell if you trust the product’s price is going to decrease. Otherwise known as ‘going short.’
You choose the sum of money or amount of units you desire to trade.
Bear in mind the leverage involved.
Put your take profit stop-loss orders.
You open your position.
The position should remain open up until whichever you close it or closed by a stop loss / take profit order, or consequently the expiration of the trading contract.
Commodity Trading Risks
Any form of investing has risks and commodity trading is not different. The main dangers to be alert of with commodity trading are:
Leverage risk: while leverage is an authoritative tool that can amplify trading achievements, it can also work on the contrary, by amplifying trading losses. If a large volume of leverage is used to place a position, even a moderately minor price drive in the wrong trend can end in sizeable losses. It is important to be mindful that losses might exceed the sum invested.
Price risk: price risk refers to the risks related to the fluctuations in product prices. Commodity trading amounts can be very volatile and while this instability can produce trading chances, it can also be a threat factor. Unfavorable price actions can result in substantial losses for you. If you do not have adequate funds in your trading account to cover probable losses, your trading positions might be automatically closed.
Managing the Risks
You can never eradicate risk when doing commodity trading, nevertheless, you can decrease it by concentrating on risk management. Below are some risk reduction or management methods:
Diversifying portfolio: a portfolio that trails an extensive range of asset classes will have a lesser level of risk compared to a portfolio that merely centers on one asset. By diversifying your collection across multiple assets such as stocks, ETFs, bonds, or commodities, you can reduce your total portfolio risk.
Determining the optimal position size: before you jump to commodity trading, you should decide your optimum position scope for each trade. A good law of thumb is to evade risking more than two percent of your principal on any particular trade. Trading more than two percent per trade could render you to losses that are difficult to recover.
Putting stop- loss in place: stop-losses are an important component of a healthy risk control strategy. Stop losses aid to minimise trading losses by closing out losing trading positions before huge losses accumulate.
In summation, commodity trading avails diverse trading opportunities. The openings offer 2-way trading actions depending on the trend they take. In essence, merchants can capitalise on both downtrend and uptrend price projections.
DISCLAIMER: This information is not considered as investment advice or an investment recommendation, but is instead a marketing communication