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Commodities Trading

Commodities trading

Disclaimer: The products or services discussed in this article may not be offered by Taurex and may only be listed here for educational purposes.

 

The world of trading has multiple areas, many of which can help generate substantial profits for traders and investors who understand the ins and outs of trading. But even with an understanding of trading, there is also equal potential for losses.

One of the significant areas in trading is commodities, and many try different strategies to get into this lucrative market.

In fact, in 2022, the commodities market’s gross margin topped $100 billion for the first time. So, if you’re interested in tapping this sector, you’ll need to answer these questions. 

What are commodities, and how do they differ from stocks and other tradable goods in the market? What is commodities trading, and how can one get into this money-making opportunity? Finally, is commodity trading worth it?

This article discusses commodities, examples of these tradable items and how they differ from stocks in the market. Also, you’ll understand the concept of commodity trading and how you can start this venture.

Furthermore, you will understand why commodity trading is worth it even in today’s fluctuating economy.

To be an all-around trader, you must learn how to work with commodities. There’s money waiting to be reaped in this area of trading and investment. However, you can only harvest these gains if you’ve learned the ins and outs of commodities trading. But again, there exists also an equal potential for losses. 

Key Takeaways

  • Commodity trading is the act of buying and selling metals, energy, agriculture, livestock, and meat.
  • The commodity market is affected mainly by supply and demand.
  • Commodities are divided into two main categories: soft and hard commodities.
  • Traders can trade with commodities using exchange-traded funds (ETFs) or exchange-traded notes (ETNs).

What Is Commodity Trading?

Simply put, this type of trading is the buying and selling of tradable goods in markets like the Chicago Mercantile Exchange (CME), London Metal Exchange (LME), or the New York Mercantile Exchange (NYMEX). 

Goods traded in global markets include oil and gas, industrial materials, precious metals, agricultural products, and timber. Commodities with similar grade and quality are described as “fungible,” which can have a standardised price for quality and quantity. 

Commodities can be physical commodities or goods or the more popular form in trading markets as derivatives or contracts with commodity prices. There are also commodity traders that invest in futures contracts when trading commodities. 

A History of Commodities Trading

If you trace back the history of commodity trading, you’ll realise that the roots of this type of trading go back to when humans first bartered goods with each other.

The primitive barter system upgraded to the mercantilism economy of ancient nations, kingdoms in the Renaissance, and even way up to Victorian times.

Now, trading is no longer confined to buying and selling physical goods. You can now trade online without even having the commodities you’ve sold.

Modern commodities exchanges have replaced the merchants and bazaars of old. Today, trading can occur online. Commodities are bought and sold in the millions in mere minutes as online trading continuously rises.

Discover How Commodities Trading Works:

If you want to understand something fully, you can learn how it works. Commodity trading works similarly to traditional buying and selling in marketplaces. The most straightforward principle in trading is that you buy low and sell high. 

Before, merchants travelled far and wide to find wares to buy low and sell these goods with high markups in cities. This merchant system was the trading environment for hundreds of years. Now, trading can be done in one place, over the internet, in one platform.

What Is Leveraged Commodity Trading?

In some cases, traders can borrow funds from lenders and brokers to increase the commodities they can buy, hoping to sell them higher later. 

This type of strategy is called leveraged commodity trading, and it can be profitable but risky. You’ll need a keen understanding of commodities and a reliable risk management strategy to “bet” into leveraging strategies. 

What Are Commodities?

As the term suggests, commodities are items or goods that can be bought and sold. Anything that has value or worth or is used by people can be a commodity. There are two types of commodities in this kind of trading:

  • Soft commodities: This type is usually any goods grown or cultivated. Examples of agricultural commodities are wheat, live cattle, corn, soybeans and tea.
  • Hard commodities: These commodities are mined or extracted from the Earth. This commodity includes natural gas, Brent crude oil, heating oil and precious metals like gold, silver and palladium.

Commodities vs. the Stock Market

Both stocks and commodities are money markets traders use for their investments. However, there are considerable differences between these two:

  • Stocks are financial securities in the form of ownership shares of the company. Many factors, including the company’s performance and growth, determine the value of these shares.
  • Commodities are naturally grown, manufactured, or mined from the ground or derivatives of mined materials, especially coal, oil and natural gas.

Another difference between the two is that stock value depends on the company. In contrast, commodity value comes from the supply and demand of the traded item.

Undated Spot Commodities vs. Commodity Futures

Another thing you should learn when dealing with commodities is their price and how it changes over time. In trading jargon, you’ll hear words like spot prices and futures. 

  • The spot price is the commodity’s actual price sold on a particular date. If “undated,” there’s no specific date given when to redeem or exchange your commodity for cash.
  • The futures price is the price of a commodity at a later date. 

You are buying commodities because of their current low price or the projected future price due to factors that you know will result in the rise in commodity price. 

Undated Commodity Markets

An undated commodity market is a market that does not specify the date when you can redeem or exchange your commodities into cash. Usually, brokers offer less cost in opening a position when undated.

Commodity Futures

When you enter commodity futures, you’re most likely to encounter contracts that obligate the holder to act at the predetermined date. Suppose the holder “unwinds” or closes a position before the determined date. The commodity can still be sold in that case, provided both parties agree on a price.

The price observed in commodity futures may not always be higher or lower than spot prices. It all hinges on the factors that you consider will affect the commodity.

Commodities’ Costs

The cost of production and the regular expenses included in retrieving, cultivating, and transporting the item affect the price of a commodity. Traders know this and make calculated decisions with cost in mind.

You’ll also need to understand commodity costing when you work with commodities. Though costing involves many factors and considerations, it can be condensed into two points of concern:

  • The cost at which the commodity gets its value in inventory considers the manufacturing activity costs.
  • The cost incurred by the commodity vendor from where consumers purchase it.

The two points give an overview of the many cost factors that can affect the prices of commodities.

Always remember that there’s a difference between price and cost. Cost is the expenditure linked to the production of the commodity. On the other hand, price is the amount consumers or traders are willing to pay for the commodity.

Types of Commodities

Traders can place their money in many kinds of commodities. However, you can categorise these items into three major groups:

Metals

There are two types of metals in trading. These two are the following:

  • Precious metals: These are metals that have intrinsic value due to their rarity. These metals are often used for bullion production and particular purposes, mainly for decorating and accessorising. Examples of precious metals are gold, silver, platinum and palladium.
  • Base metals: These are metals that gained value due to their industrial uses. Examples of base metals include copper, nickel, lead and zinc.

Energy

You can invest in commodities that are raw materials needed for energy production. Commodities that are usually used for energy production are crude oil, coal, and natural gas.

Because using fossil fuels impacts pollution levels, alternative energy sources have also become part of the energy commodity. Examples of alternative energy sources are solar, wind, water and biofuel.

Agriculture

The food industry has the biggest range of commodities in the global market. Examples of agricultural committees include livestock, corn, wheat, sugar and cotton. Any produce of farms and various cultivation means aimed to support a country’s growing population falls into agriculture. 

Special Characteristics of the Commodities Market

The commodities market has unique special characteristics that make it dynamic.

The first thing that affects this market is the supply and demand of commodities. Traders need to understand the factors affecting the supply and demand of traded goods.

Disruption in the supply can affect the value of the commodity in the market. For example, a disease affecting livestock can lead to a spike in the stable market, which can result in an increase in prices but a decrease in volume.

Other factors that affect the commodities market are global economic developments, technological advances and political issues. An example is the tensions between nations or the industrial and economic growth of major international players like China, India and Russia.

Choose What Commodity You Want to Trade

Before making the first step in commodities trading, you must choose the commodity you want to invest in. Depending on your preference and situation, you can choose from many commodities, but your choice will have pros and cons.

Hard Commodities

Tradable goods drilled or mined to acquire are commonly listed as hard commodities. With this definition, all mined products like precious and base metals fall into this category. Byproducts of mined commodities are also listed under hard commodities.

The characteristics of hard commodities are the following: 

  • Hard commodities are labour-intensive, meaning acquiring and extracting these resources from the ground requires money, time, and energy.
  • Hard commodities require a massive capital investment.
  • Because of the considerable investment in capital and resources, most hard commodity manufacturers are multinational corporations.
  • Because of commodities’ properties, traders can store hard commodities for extended periods.

Soft Commodities

Tradable goods grown, cultivated or raised, mainly from the ground, are listed as soft commodities. This definition puts all livestock and crops in the “soft” category. Like hard commodities, byproducts of “soft” goods are also listed under the soft commodity category.

    The main characteristics of soft commodities:

  • Soft commodities futures have higher volatility than hard commodities.
  • Environmental factors like drought, flooding, and storms affect soft commodities.
  • Soft commodities can’t be stored for extended periods, limiting their trading time frame compared to hard commodities.

Trading Commodity Options

When discussing commodity options, you are talking about a trader or investor’s opportunity to buy or sell a security at an agreed-upon or strike price on a specific day.

The holder of the commodity has the right to buy or sell the commodity but isn’t obligated to do so, even if the contract reaches its expiration.

Options are helpful for traders who want a leveraged position over a commodity they’re interested in. Some investors use options to reduce the exposure risk of their portfolio.

Using Stocks to Invest in Commodities

Investors who want to enter the market to invest and trade in a particular commodity can do so by buying stocks. Traders can instead invest in a company related to the specific commodity rather than the tradable goods.

For example, instead of investing in oil or natural gas, an investor or trader can buy stocks of companies related to the production and delivery of oil and natural gas.

Traders may buy stocks from refining companies, drilling companies, and refineries or put their investments in tankers. Investors can use stocks as a way of investing in commodities.

Compared to actual commodities, stocks are less volatile as they rely on the stability and ability of the company to maintain its lead in a particular market and not on the factors that affect commodity prices. Thus, company stocks or shares tend to have less dramatic price movements than other commodities.

Another advantage of investing in stocks and trading in the stock market is that it’s easier due to many brokers. Furthermore, a company’s financial situation is public information, especially if they’re a stock and commodities market player.  

However, there are still some disadvantages when buying stocks. One is that because the stock’s value depends on the company, any internal factor that might cause an issue affects the stock value.

Even if the commodity gains impetus in the market, your stocks can lose their market price because the company is weakening.

Using Futures to Invest in Commodities

Aside from investing in stocks, you can trade in the commodities market through a futures contract. When you talk about a futures contract, it is a legal agreement to either buy or sell a commodity at an agreed price at a specified future date. 

Also, when entering a futures contract, you, as the buyer, are obligated to buy and receive the commodity when the contract expires. Note that the contract’s expiration date is the predetermined date when you either buy or sell the commodity. 

When discussing futures, the seller must provide and deliver the underlying commodity before the contract expires. 

Livestock and Meat

Livestock is a massive market in trading. Still, many factors like pestilence and widespread diseases can ruin the market. For new traders, direct investments in commodity futures contracts can be risky. Big trades with potential profits can lead to magnified losses when the trade doesn’t go well. The event could result in the loss of the initial deposit.

One way to lessen the risk is by purchasing options. You retain the right to buy or sell but are not obligated to complete any transaction. Suppose you’ve entered into a futures option contract, and the price doesn’t go in the desired direction. In that case, you can limit your loss to only the purchase option’s cost.

Using ETFs and Notes to Invest in Commodities

Another way of trading in the commodities market is to invest in ETFs (exchange-traded funds) and ETNs (exchange-traded notes). These two are options that traders can purchase to profit in the commodities market despite the fluctuations. 

How ETFs work is that through this option, you can trade in more than one commodity, which makes it a good way of diversification. With ETFs, you invest in multiple assets, stocks, and bonds.

On the other hand, ETN is debt, with the promise that the issuer pays the agreed price on an agreed-upon date. However, inexperienced traders can dive into purchasing ETNs and then discover that the issuer defaulted before the expiration date, resulting in a loss.

To simplify, ETF is an option to invest in a basket of commodities, hoping that on a future date, it will be bought or sold at a price profitable for the investor. In comparison, ETN is an option to invest in debts promised by an issuer paid at an agreed-upon date at a profitable price for the investor.

Another thing to consider is ETCs (exchange-traded commodities), which are commodities traded in a stock market. ETCs allow traders to invest in a particular commodity or multiple commodities with high liquidity specified by the trader.  

Using Mutual and Index Funds to Invest in Commodities

A mutual fund (MF) is a pool or “collection” of assets from different investors willing to use their combined assets to invest in any particular commodity they’ve agreed upon. This fund is often managed by professional money managers who allocate the funds to ensure the most profit whenever possible.

An index fund, a type of mutual fund, is a portfolio or collection of stocks, bonds, and assets with lower expenses and fees than actively managed funds.

You can’t directly invest in commodities with mutual or index funds. Still, a professional money manager can work with these funds and ensure that a profit or sustained passive income is generated from your investments.

Using Commodity Pools and Managed Futures to Invest in Commodities

A commodity pool (CP) is a collection of investments from different investors who have agreed to use the funds to speculate in futures, options and swaps.

The benefit of investing in a commodity pool is that you can have access to or leverage in the market as you have bigger purchasing power.

The funds are operated by a commodity pool operator (CPO), which manages the fund and advises the participants on possible money-making investments and opportunities.

A CPO can also help, alongside other trading advisors, advise the investors in a commodity pool to invest in managed futures contracts in the commodities market.

Commodity pools and mutual and index funds allow an investor to have more comprehensive access to the market by teaming up with other investors.

Instead of placing all your money into a particular commodity, you can put your money in a pool and rely on the collective’s combined decision-making capabilities backed by professional money managers and trading advisors.

The risk is significantly lower if you invest in a CP or an MF. However, the profit may potentially be less. 

Are Commodities Worth Trading?

There are many pros and cons in commodities trading, depending on whether these affect you as a trader.

Here are the pros of commodity trading:

  1. Commodities can help you earn short-term profits: You can make money if you continually monitor your investments, selling and buying at the right moment in short periods. If you desire to keep on top of the situation in trading, this can be an option. You can also take advantage of brokers to help you manage commodities.
  2. You can use commodities as a hedge against inflation: Observations tell traders that commodities tend to rise in value when the USD (U.S. dollar) drops. An example is the price of gold, which tends to increase during economic uncertainty, inflation and recession.

Still, trading commodities has its disadvantages. 

Here are the cons:

  1. Commodities can be volatile: Investing in commodities has risks because the factors that can negatively affect an investor’s chance of getting their equities come from forces out of any person’s control. These factors include political unrest, disasters, local economic problems, and geopolitical issues.
  2. Commodities don’t produce regular income for investors: Investors earn nothing unless the commodities are sold at a profit. So, when investing in this market, an investor shouldn’t expect any regular income unless appropriately managed by a competent money manager or pool operator.

After considering the pros and cons of commodities trading, you can decide whether this trading opportunity fits you.

How Can You Trade in Commodities?

Once you’ve decided that trading commodities is worth your investment and time, here’s how you can start trading. 

Remember that you can contact trading professionals whenever you have doubts or questions about this form of investment. Here’s a list of things to know when you want to start trading:

Learn What Moves a Commodity’s Price

Many factors can affect the price movement of a commodity. As a trader, you must know these factors to make informed decisions on trading.

  1. Politics: Because commodities tend to come from different countries, especially hard commodities like metals and those related to energy production, local political issues can have massive repercussions in the market.
  2. Commodity prices: Supply and demand drive the commodities market. Many factors, which include production problems, political disputes between countries, and disasters, affect supply and demand. 
  3. Growing competition: The commodities market is competitive. For example, new technologies and climate change awareness gave rise to the renewable energy commodity. Because of this, fossil fuels can experience a dip in investments due to the shift of investors willing to spend money on clean energy. 
  4. Macroeconomics: A country’s economic health can also influence the price of commodities. Weak economies tend to lower the demand, causing a dip in commodity prices. A booming economy results in high market activity and a balance of supply and demand.
  5. Seasonal characteristics: Commodities, especially soft commodities, have seasons when farmers plant, raise and harvest their crops. Because of this, investors can determine when to buy, hold or sell their commodities, depending on the cultivation season of each product. For example, the price of a bountiful harvest of corn may be driven down due to oversupply.

Choose a Commodities Market to Trade

There are many commodities to choose from. You can start trading with soft commodities like wheat, corn and other asset classes. You must select a commodity you are familiar with to make better decisions.

Spot Prices

When you want to decide how to manage your commodity trading strategy, you should be aware of the spot prices of each commodity. The spot price is a commodity’s current or present price at the time you’ve checked. Spot prices can help determine whether you should buy now or sell later.

Decide Whether to Trade or Invest

Knowing the spot price can help you decide whether to initiate a trade and sell your commodity assets or invest more because of the low prices. Leaning spot prices and how factors affect their rise and fall can help you in your trading abilities.

Open a Live Account With Us

When you trade, you’ll need a credible trading platform to monitor market indexes and the performance of commodities. You can choose from three powerful trading platforms: MetaTrader 4, MetaTrader 5, and Taurex App. 

Through these platforms, you can monitor real-time market activities. Active monitoring of commodity performance lets you make informed decisions when you apply your trading strategy.

You can create a demo account to test your skills in trading without risking any money. However, you can set up an account and begin trading if you are confident in your trading capabilities.

Find a Commodity Opportunity

You need to keep track of the factors that affect prices when trading in the commodities market. The best way to be on track is to monitor financial news and use technical analysis and indicators. You can also depend on the advice of trading experts and money managers to correctly identify commodity opportunities, trading signals, and alerts. 

How to Invest in Commodities

Here are some methods to invest in the commodities market. Most traders will focus on one of these ways to profit in commodity trading. 

Invest Directly in the Commodity

The most straightforward way of investing in a commodity is physically buying and storing it properly until prices are good enough to make a profit after a sale. This option is easy for precious metals in small quantities. 

An example of this is gold and silver coins or jewellery. You can store them and sell them when needed or profitable. However, the problem with this type of investment is storage and logistics, especially commodities like livestock and farm produce.

Invest in Futures Contracts

You can trade using derivatives like a futures contract as long as it’s allowed by your brokerage account. However, investing in a futures contract is geared more towards major companies than individual investors. 

Invest in Commodity Stocks

You can also invest in shares or stocks of companies that produce, manufacture and process soft or hard commodities. Instead of investing in the commodity itself, you are investing in the company that utilises it. 

Invest in Commodity ETFs and Mutual Funds

You can invest in ETFs, which is a “basket of commodities,” that diversifies your investments. Instead of investing in one particular commodity, you can invest in ETFs and put your money into a collection of commodities. 

You can also join mutual funds where professional money managers take the lead in advising participants on the best investment or decision at any particular time. 

Should You Trade Commodities?

You can trade in commodities, as you can invest in various goods.

Should You Invest in Commodities?

There’s a difference between trading and investing in commodities. Trading is buying and selling goods for profit, especially in short terms. However, investing is a long-term commitment to accumulating wealth by putting money into a commodity you believe will increase in value over time.

You may choose to trade if you want a fast-action, money-making strategy. However, if you’re more of a laid-back individual who wants security in the future, investing in something worthwhile may be the choice you ought to make.

Disclaimer: The information provided in this article is for general informational purposes only and does not constitute financial advice. It is not intended to be a recommendation to buy or sell any financial instrument or engage in any investment activity.

While we strive to provide accurate and up-to-date information, we do not guarantee its completeness or accuracy. We rely on various sources for the information presented, and we cannot guarantee the reliability or accuracy of these sources.

The information provided here does not necessarily reflect the products or services offered by our company. Any mention of financial products or services is for informational purposes only and should not be considered an endorsement.

All investments involve risk, including the potential for loss of principal.

This information should not be considered as financial advice. You should always seek professional financial advice from a qualified advisor before making any investment decisions.

References

  1. Commodities Trading: What You Need To Know https://www.forbes.com/uk/advisor/investing/commodities-trading/
  2. Using leverage to trade commodities https://www.readersdigest.co.uk/money/investment/using-leverage-to-trade-commodities
  3. Cost vs. Price: What’s the Difference? https://www.investopedia.com/ask/answers/101314/what-difference-between-cost-and-price.asp
  4. What Is an Option? https://www.investopedia.com/terms/o/option.asp
  5. What Is an Exchange-Traded Fund (ETF)? https://www.investopedia.com/terms/e/etf.asp
  6. What Are Index Funds? https://www.investopedia.com/terms/i/indexfund.asp

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