Trading commodities is one of the oldest forms of trading, going back to ancient societies, where it could be used to determine the strength of an empire. Involving a physical asset, commodities are now traded globally, in a variety of different ways, including future contracts (futures) and contracts for difference (CFDs).
An investment in commodities is usually a stable asset in a trader’s portfolio, especially gold, as their price movements are affected differently compared to other markets, and tend to be reliable during volatile times. If you’re thinking of including this type of asset in your investment strategy, let us explain more about what a commodity is and how to trade in it.
Commodities Definition
Commodities are goods or material that can be bought or sold on the market. In terms of the financial market, they can come in two varieties: Hard or Soft. The first includes the commodities that are naturally found materials that are mined or extracted, such as oil or silver. The latter includes commodities that are grown or produced, such as the farming goods, wheat or corn. Crude oil trading is the most popular, and is classed as a ‘hard’ energy resource.
The price of either type of commodity is based mainly on the process of supply and demand, but can also be impacted by several external factors, such as global events, geopolitics, natural disasters and pandemics, as we explain further on. All of which should be taking into consideration when investing in the commodities market.
Trading Commodities
As previously mentioned, there are different ways you can trade in commodities, but the main ones are futures and CFDs.
Futures are commonly used by the companies that directly use the commodity in question, for example, exchanging oil in the automotive and airline industries. In this type of trade, the price is agreed upon in advance, and the asset is bought and sold at this fixed price on a future deliver date. This reduces risk and volatility, and is easily included in a budget plan for these industries.
With oil CFDs, traders can speculate on the price movements of that asset in the market, usually based on the futures from the world’s major commodity exchanges. CFDs are a financial derivative, so the underlying commodity is not owned by the trader, and there is no need for organisation of delivery or relevant storage facilities. CFDs also allows the trader to use lower amounts of capital, through leverage trading, as well as open a position on both a rising and falling market.
For both types of trading and all varieties of commodities, it requires a lot of research and analysis of trends. Using price charts, historical market movements and predicted trends for price movements, are all beneficial in making trading decisions. Traders will use this information wisely, to estimate the future price movements, and the likely disruption in either the supply or the demand for the commodity. In traditional trading, the aim is to buy when the price is low and to sell when they are high to result in a profit. With a short-selling technique, or through CFD trading, you can take a position on a falling market.
Factors That Affect the Commodities Market
When understanding how to trade commodities, it’s important to know what can impact the market and the value of the assets, as well as the relationship between supply and demand. Gold and silver, for example, can be impacted by the surge in demand for jewellery. Or during political uncertainty, interest in precious metals can pique in order for investors to protect their wealth. US politics, in particular, can affect the value of both oil and gold; West Texas Intermediate (WTI) is produced in America, and is a grade of crude oil used as a benchmark in oil pricing, whereas the value of gold is typically based in US dollars, so the rise or fall of the currency can affect the price of the commodity.
Some factors cannot be predicted, such as unusual weather or natural disasters, that can destroy the production of crops, for example. Or the recent global pandemic, which halted the demand for oil when there was a surplus of supply of the commodity. These uncontrollable factors should be considered as a risk element when trading commodities.
