Commodity Trading Basics You Need to Know
Commodity trading is one of the most lucrative venture an investor can try. That’s because it offers a lot of benefits. The only thing you need to have is a small amount of capital and the knowledge of the market.
To start trading commodities, you should first understand the market’s most basic concepts. What are commodities? What are its different types? How can we trade them?
What are Commodities?
A commodity is a basic good or raw material that commerce participants use. In other words, these commodities are the building blocks of a bigger good or service.
There are a lot of commodities in the market. But you only have to think about four of them when you want to try commodity trading.
- Agricultural Commodities (sugar, coffee, cotton, beans)
- Energy (petroleum, oil, gas)
- Metals (copper, gold, silver, platinum)
- Livestock (pork, live cattle, meat)
How are they different?
Apart from their general types, these commodities also differ in terms of liquidity and ease of access.
Some commodities see higher trading volumes than others. Feeder cattle trading, for instance, isn’t as active if you compare it to crude oil trading.
Supply and Demand Drive Prices
Commodity prices primarily move according to supply and demand dynamics.
The supply, on the one hand, moves according to different factors. Such factors include:
- Government policies
- Industry regulations
Government sanctions also affect the supply greatly. For instance, the US may impose sanctions on oil producing countries. Then, the supply would decrease.
Lower supply levels mean a probable increase in price.
On the other hand, demand can also move according to those factors. Consumer habits and the economic health primarily drive the demand.
Ways to Do Commodity Trading
To trade commodities, the most direct way is to buy the commodity itself and wait for prices to go up.
However, it’s also the most impractical, as you would be receiving the delivery of the actual bags, herd, or bars of commodities.
Here are some of easier way to trade commodities.
Commodity funds let you expose yourself to commodities without having to buy them directly.
Just like many other types of funds, it offers quick and easy diversity. That’s because a fund may invest in various commodities at once.
Commodities also have historically low correlation to the stock market. As a result, commodity funds serve as good hedge if you have equity holdings too.
You can also find commodity stocks, or companies that deal heavily with commodities. The only downside of this is that when commodity markets experience weakness, these companies also decline.
Commodity futures are generally pure play on the underlying commodity. It also gives you the chance to use leverage, which lets you achieve bigger profits even with small movements.
On the other hand, the futures markets can experience high volatility. At the same time, leverage also magnifies your chances of losing even it as increases your possible gains.
Commodity options let you trade on the stocks of commodity-heavy companies, but with smaller investments than actually buying stocks.
Your risk will only depend on the price of the option. Options on commodity stocks are also typically highly liquid.
The downside is that your earnings or losses potential can change due to company-specific factors. In other words, commodity options aren’t a pure play on commodities.