What is Commodity Trading?
Commodities trading is the buying and selling of
different commodities or their derivatives with the
aim of making a profit out of their price changes.
Commodities are vital for human existence, and have
been traded since immemorial.
Traditionally, commodities were traded arbitrary or
informally, but nowadays, they are mainly traded
with standardised quantities and quality on major
centralised global exchanges, such as the Chicago
Mercantile Exchange (CME), New York Mercantile
Exchange (NYMEX), Intercontinental Exchange (ICE),
and the London Metal Exchange (LME).
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account to practice what you’ve learned or
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What is a Commodity?
There are mainly three types of commodities commonly
traded (categorised according to their utility):
metals, energy, and agriculture.
Metals
are hard commodities (mined from the ground) that
are typically used in construction. Some metals,
such as gold, also hold aesthetic value and are used
for investment purposes as well as jewellery.
Precious metals are also sometimes used by investors
as a hedge against inflation.
Energy
commodities are also classified
as hard commodities, and they are used to generate
energy that powers the global economy. Energy
commodities include oil and natural gas, and they
are used to power factories, facilitate the
transportation of goods, and even heat our homes.
Agricultural
commodities are classified as
soft commodities (grown and harvested or reared
above the ground), and they are typically used as
human food, with some having some industrial uses.
Agricultural commodities include sugar, cotton, and
wheat. Livestock and meat products, such as pork
bellies and live cattle, can also be classified
under agricultural commodities.
What is a Commodity Market?
Commodities are primarily traded in 4 markets: spot,
futures, options, and forwards. On the spot market,
commodities are traded or exchanged using the live
current price rates. A popular way of trading in the
spot market is using commodity CFDs
(Contracts for Difference).
On the commodity futures market, a contract holder
has the right to buy or sell a set amount of the
underlying commodity at a set price on a set date in
the future.
In commodity options trading, commodities are traded
in the same manner as in the futures market, but a
contract holder has a right, but not an obligation,
to exercise it.
In the forwards market, contracts are generally
private and customised between parties, and the
trade is conducted Over-the-Counter (OTC).
Apart from the spot commodities market, the other
markets focus on the future prices of an underlying
commodity. The curve of future prices can either be
rising or falling or, in other words, experience
contango or backwardation. In a contango
pattern, commodity prices are expected to rise in
the future (higher than current spot prices);
whereas in a backwardation pattern, prices of an
underlying commodity are expected to fall in the
future (lower than current spot prices).
How to Trade Commodities
To trade commodities effectively, it is important to
first understand what influences their price
changes. Here are some of the factors that impact
the supply and demand of commodities:
- Global Economic Conditions –
As essential human products,
commodities tend to be sensitive to changes in
global economic conditions. Their demand tends
to grow during periods of economic boom while
slumping during periods of economic
uncertainties.
- Consumer Trends –
Commodities are utilised by consumers,
and their changing tastes and preferences can
impact their demand and consequently influence
their prices. For instance, the growing demand
for electric vehicles can lead to more demand
for metals such as lithium and cobalt, while
simultaneously decreasing the demand for oil.
- USD Strength – Prices of
commodities in the international markets are
denominated in US dollars (USD). This has
created an inverse correlation between the
strength of the USD and commodity prices. When
the US dollar value strengthens, commodity
prices tend to fall, and vice versa.
- Politics – Political
policies and events directly impact commodity
trading in the international markets. For
instance, in the oil market, OPEC is a major
intergovernmental organisation that can
influence oil prices by institution production
cuts or boosts by their members. Geopolitical
events, such as military conflicts,
import/export taxation, and trade wars, can
significantly impact the demand and supply of
various commodities.
- Weather – Weather
conditions particularly have a massive influence
on the production of agricultural goods. Extreme
weather conditions, such as floods, hurricanes,
and other natural disasters, can impact the
production and transportation of agricultural
commodities and directly impact their prices.
Forecasts of exceptionally warm or cold winter
season can impact the demand for energy
commodities as well.
Prices of commodities are influenced by diverse
factors, and traders must incorporate an effective
risk
management plan in order to trade them
effectively. Traders typically hedge spot positions
by opening alternative trades in futures, options,
or forwards markets. For instance, if you have
bought gold in the spot market, you can hedge that
position by buying a put option contract that will
be in profit when prices fall.
Build Your Commodities Trading Strategy
Commodities are excellent assets to trade. They
feature great bullish and bearish price cycles and
provide numerous lucrative opportunities for both
short-term and long-term strategies. Commodities
also serve as good hedges against inflation as well
as practical diversifiers of portfolios composed of
assets, such as stocks and bonds.
When building a commodity trading strategy, it is
important to evaluate both fundamental and technical
aspects of the underlying asset. Fundamental
analysis involves investigating supply and demand
factors so as to establish the intrinsic value of a
commodity. For instance, a wheat trader should be
able to track factors such as oil prices, weather,
demand from importing countries, production
statistics from exporting nations, as well as
government taxes and policies.
On the other hand, technical analysis involves
predicting future prices based on the past price
action of an underlying commodity. For instance, an
oil trader can use mathematical indicators, such as
trendlines and Fibonacci tools, to establish
short-term trends or potential trend reversals in
the market.
Advantages of Trading Commodity CFDs
One of the relatively easy and low-cost ways to trade
commodities is via the CFDs market. When trading
CFDs, you do not own the underlying commodity, but
you only speculate on its price changes. Here are
some of the advantages of trading commodity CFDs:
- Leveraged
Trading – CFDs are
leveraged products, allowing you to boost your
overall trading capital. With leverage, you can
also make bigger profits out of small price
changes in the market, but keep in mind that
leverage increases your risks by the same
multiplier.
- Buy or Sell Without Restrictions –
Go long or go
short according to market conditions.
- Risk Management Tools –
Use limit orders and conditional
orders, such as stop loss and take profit, to
manage your risks in the CFD market. You can
also perform hedging strategies without any
restrictions.
- High Liquidity – A CFD
contract is between you and your broker, which
ensures that there will almost always be
sufficient liquidity.
- Low Trading Costs – CFDs
trades only have spread fees, which can be as
low as 0.01% of your overall position.
Final Words
Commodities are great financial assets to trade. Open a free
demo or live account and explore
opportunities in the commodities market with
Nexioval. Nexioval is a highly regulated CFD
commodity broker that features advanced
trading platforms that give you access to
various commodities, as well as other financial
asset classes such as stocks, forex,
cryptocurrencies, ETFs, bonds, and options.
Open a Demo
account to practice what you’ve learned or
a Real account to start trading today!
FAQ
-
What
are the 3 types of
commodities?
The three types of
commodities are energy,
metals, and agriculture.
-
Is
commodity trading
profitable?
It can be profitable,
however, commodity prices
are very volatile. This
volatility provides plenty
of potentially profitable
trading opportunities, while
also being the main source
of market risks.
-
How do
I start commodity
trading?
Open a demo or live
Nexioval account.
Choose from the catalogue of
commodities available to
trade and decide whether to
go long or go short.