Commodity as defined by the English dictionary is a raw material or a primary agriculture product that can be bought, traded or sold, some examples include; copper, coffee, and sugar. With that it can be easily assumed that commodities are materials that can be used in everyday things. Commodities play important roles in our daily lives and there are countless raw materials that can be found all over the world. Commodity trading in the World Market is one of the most diverse and active trade in the market.
Like in any investment, the goal in commodity trading is to buy low and sell high. There are only two ways to trade in commodity, one is spot and the other is futures market, which is the most common form of individual trade in the commodities market.
For traders, commodity trading is the best way to diversify their trading portfolio beyond conventional securities or assets. Many market participants rely more on commodities because their price moves in reverse to stocks during the interval of market volatility.
In the past time, commodity trading was mainly limited to experienced traders and required significant money, amount of time and expertise. But coming to the present time, the market participants have a wide variety of options to participate in the commodity market.
How to Invest in Commodity Trading
A famous way to invest in commodities is through a futures contract, which is an agreement to buy and/or sell, in a given date, a specific amount of a commodity at a specific price. Futures trade is available on every category of commodity.
Two types of inventories participate in the futures markets:
- Commercial or institutional users of the commodities
Exchange traded funds and exchange traded notes which traded like stocks, allow investors to participate in commodity price fluctuation without directly investing in futures contracts.
Types of commodities
This category of commodities includes farm products such as soybeans, wheat, cocoa, rice, cotton, sugar, corn, sugar and coffee. When considering the agricultural sector, grains can be highly volatile during the summer season or any interval of weather-related changes. For traders who wish to trade agricultural products limited agricultural supply combined with population growth can bring vast opportunities for profiting from surging agricultural product prices.
Energy commodities comprise of:
- Crude oil used in the production of plastics and transportation activities
- Natural gas used in the generation of electricity
- Gasoline which is fuel for light-duty cars and trucks
Metals commodities include silver, copper, platinum and gold. At the time of bear market or market volatility, some traders may choose to invest in luxurious products. Mainly it includes gold because it is regarded as status symbol, dependable and reliable metal with conveyable, real value. Traders also trade in precious metals to protect their investment from currency devaluation or high inflation.
4) Meat and Livestock
Meat and livestock commodities consist of pork bellies, lean hogs, feeder cattle and live cattle.
How are Commodities Traded?
Commodity trading is slowly expanding. Modern commodity market also includes financial assets such as foreign currencies and indexes. Further, digital innovations have also made it possible for traders to trade on a mobile phone, anywhere and anytime. Commodity trading is done through various exchanges.
Some examples of global commodity exchanges are as follows:
- Chicago Mercantile Exchange (CME)
- Chicago Board of Trade (CBOT)
- Intercontinental Exchange Inc. (ICE)
- London Metal Exchange (LME)
- Multi Commodity Exchange (MCX)
- New York Mercantile Exchange (NYMEX)
Trading differentiated Products
The commodity market is the main marketplace where both differentiated products and commodity products are traded. But there are certain differences between them.
Every type of commodity is similar regardless of their source, and they are interchangeable too. Simply, it means that brent oil from one producer is similar to that of brent oil from another producer. Thus, the trader can mix two commodities without any effect on the quality of the resultant commodity.
Differentiated products stand in clear contrast to commodity trading. These products are unique and are not the generic version of the item. For instance, the price of regular gasoline is the same across all the oil-producing firms. But, the scene reverses when the company manufactures high-octane gasoline. Now, the price of this gasoline product will definitely be higher in comparison to its competitors.
Steps for trading commodities
1) Select the financial market
Select the commodity which you wish to trade such as gold, Brent, crude oil or natural gas.
2) Decide whether to purchase or sell
If you anticipate that price will decline in future then choose to go short (sell). On the other hand, if you anticipate that price will surge in future then choose to go long (buy).
3) Select the trade size
Decide the total units you wish to trade. The value of a unit changes depending on the tools or asset you have chosen to trade.
4) Manage your risk
Risk is inevitable in the financial market, but the trader can mitigate it to some extent. There are various tools through which you can hedge risk. Choose from several stop-loss orders such as GSLOs (guaranteed stop-loss orders). Guaranteed stop-loss orders dynamics is similar to that of regular stop-loss orders.
Various financial service providers also provide a tool for hedging risk and tutorial for risk management. One such authentic firm is HFTrading. The award-winning brokers offer various courses for beginners and experienced traders. The educational hub of brokers includes tutorials, articles, videos on demand and courses.
5) Monitoring your trading position
After placing the trade order, it is important to monitor the open positions (including take profit orders and stop orders). The real-time monitoring of your loss and profit helps you to set the right bid and earn from sudden market shifts. Losses might exceed deposits; this is another reason why close monitoring is essential.
6) Close your trading positions
Monitoring the trading positions and closing them at the right time is important. It protects the trader from unwanted losses. One can also use a stop-loss order provided by the broker. It helps traders to sell or buy a specific asset when it attains a certain price.
How to open a commodity trading account?
For trading commodities, the very first thing which a trader requires is an online trading account with an authentic brokerage firm. The process of opening an account is more or less similar for all financial service providers. It includes the following steps:
1) Visit the site of the broker and check whether the URL is correct or not. Get yourself registered by entering details such as name, surname, profession, email id and phone number for verification.
2) Upload the documents to verify that data provided is authentic. The documents required are a scanned copy of national id card, passport and bank and financial statements of the last three months.
3) Choose the market and product which you wish to trade and deposit the fee.
4) After the formalities as mentioned above, you can start trading.
One of the popular financial service providers is HFTrading. It allows trading on a wide variety of assets including forex, cryptocurrency, commodity, stock and indices. The minimum charge to open a trade with the broker is $250.
Factors influencing the price of commodities
Before starting commodity trading, a trader or investor should be ready and prepared to understand how the commodity market works. There are numerous factors which affect the price of commodities. Hence the difference between a successful trader and unsuccessful trader lies in how they consider these important factors while setting bids on items.
Following are some important factors which affect the price of commodities:
1) Government policies
Policies of the currency government also influence the price of commodities. Especially their import and export rules and restrictions for the seller and buyer will have a massive impact on prices. For example, if the government decided to surge the import duty on grains, then the price of this product will surge in response.
2) Economic policy
Political and economic events of the country, which is either using or producing the commodity play a vital role in influencing the price of the commodity. The low economic conditions of the country decline the purchasing power of the citizens. Thus, as an outcome, the demand for a commodity decreases, and it also impacts the net movement of prices.
3) Transportation factors and storage
All the commodities are available in their real physical form, and hence there is no requirement to store before distribution. These items do not fall under the category of purely financial items, so storage and inventory cost does not have a larger influence on the market prices. So, this factor does not influence the costs across all tradable commodity asset classes in an equal magnitude. Rather, it depends on the kind of commodity being considered.
4) Supply and Demand of commodity
Supply and demand are the vital factors which impact the movement of the price while trading commodities. The rule of supply and demand is the same for both types of trading stock market trading and commodity trading. Both these factors themselves depend on the international conditions, national condition, seasons and other important factors.
With the increase in the demand/supply for a particular commodity, the price increase/decrease. The price of precious metal and Giffin goods is an exception to this. They do not follow the general rules of demand and supply.
5) Weather Situation
Many commodities traded in the commodity market are agricultural products. The production of these goods entirely depends on the weather conditions, and among them, most of the products are season based. A small variation in the weather conditions might impact the availability of these goods in the global market. Thus, there is nothing wrong in considering this factor while investing in commodities.
6) Costs involved in the storage
There are mainly two types of costs related to storing commodities. The first is the financial cost, and the second is the cost of physical storage. Both these costs play a vital role in price evaluation. Thus, traders need to consider them before computing the forward prices.
Advantages of commodity trading
Some major advantages of commodity trading, which makes it a better choice among traders are:
1) Provide security against inflation
Inflation is not suitable for regular trading. At the period of inflation, the bond and stock investment suddenly goes down. On the other hand, the commodity market shows a positive response at this time. It is because when the price of services and goods surge, the raw material or products required to manufacture these services and goods will automatically surge. Thus, by maintaining some commodities in the trading portfolio, one can take advantage of financial market upswings.
Diversification refers to investment in various markets or products which reacts differently to variation in the financial market. It helps in keeping the annual gains stable and will also mitigate the huge losses. If you are looking forward to hedging against the bond and stock investors, investing in the commodity market can be an appropriate option. It will manage financial risk in the stock market.
3) Higher growth opportunities: The rapid surging demand for commodity trading can see price progress significantly from time to time. It allows a lot of trading opportunities to create quick income through investment in commodities.
Disadvantages of commodity trading
The trader should never risk his/her hard-earned money without looking into the drawbacks of any investment or market. So, here are some drawbacks of commodity trading.
1) Sometimes, no income generates
Commodity trading does not generate high income for the traders. Whereas, when we look into other assets such as bonds and stocks, they generate a comparatively larger profit.
2) Commodity trading is highly volatile
When compared with other assets, commodities are highly volatile. As per the study, commodities are almost four times as bonds and twice as volatile as stocks. Thus, it makes commodity trading a risky venture to invest in. It is an important point which traders should consider before entering into financial market trading.
Key takeaways of article
- Commodities are primarily segregated into five broad categories, including energy, meat, metal, agriculture and livestock.
- For traders, commodities can be an important entity to diversify their trading portfolio beyond traditional securities.
- Various factors influencing the price of commodities are government policies, economic policy, transportation factors and storage, supply and demand of the commodity, weather situation, costs involved in the storage.
- Advantages of commodity trading include: provide security against inflation, diversification and higher growth opportunities
- Disadvantages of commodity trading include: sometimes, no income generates, and commodity trading is highly volatile
The Bottom Line
The commodity market is one of the popular markets where traders get the opportunity to trade a wide variety of commodities. But at the same time, this market is highly volatile and risky because it has an immense influence on the country’s economy and routine life of people. Also, commodity trading is subjected to frequent fall and rise in the price, which makes it far riskier.
Hence before entering the market one should go through all the essential concepts and fundamentals of risk management. Hopefully, the article covered maximum points. You can also refer to the article on Different methods of commodity trading to enhance your knowledge.