How To Start Commodity Trading
Many investors favour trading commodities such as oil, gold and silver, seeing them as a relatively safe holding whose prices tend to be more stable in the market. See also our guide to Golden Cross Strategy.
If you want to understand how commodity trading works, this article walks through the main methods, what moves prices, the types of commodities you can trade, and the costs involved.
What Is Commodity Trading and How Does It Work?
Commodities in the forex market fall into several groups. The first is agricultural commodities, which include raw goods such as sugar, cotton and coffee beans.
Then there are metal commodities: precious metals such as gold, silver and platinum, as well as base metals such as copper.
There are also energy commodities such as petroleum products including oil and gas, and livestock commodities such as meat.
Across these categories, a commodity is essentially a naturally occurring material that is gathered and processed for use in human activity.
These commodities form the base of national economies, because raw materials are needed to produce food, clothing and energy.
Commodities are traded worldwide through various exchanges, usually in the form of futures contracts, which are agreements to trade at a set price and time.
A futures contract is based on the estimated price of an asset and does not transfer ownership of the physical commodity. That is part of what draws investors to this type of trading: they are not required to actually own the asset, but can still trade it when the timing suits them.
Steps to Trade Commodities
A trader can gain direct exposure to the commodity market by buying or selling shares of companies involved in mining, agriculture, harvesting, extraction or any type of commodity production.
It is worth remembering that the relationship between a commodity and a share is variable. The prices of some commodities move in the opposite direction to shares, which is why many investors and traders use them to hedge their portfolios.
For example, if the oil supply chain hits a problem, oil companies may suffer in the short term, yet the oil price itself can rise as demand outstrips supply.
The prices of some other commodities may move in parallel with the shares tied to them. For instance, when the gold price rises, mining company shares generally tend to rise as well.
A number of factors move commodity prices:
Supply and demand: supply and demand is one of the biggest factors affecting commodity prices. The supply of a given commodity is influenced by several things, such as government decisions, weather and wars.
Competition: introducing new technologies and substitute goods can reduce demand for older commodities. For example, rising demand for renewable energy has noticeably lowered investment in oil.
The wider economy: a weak economy usually lowers demand for commodities, especially those tied to construction and transport, whereas a strong economy raises demand and can push prices up.
Political decisions: political decisions can at times cause changes in commodity prices, particularly for commodities linked to exports and imports.
Seasons: agricultural commodities depend heavily on seasonal timing, which ultimately affects production and harvest. Prices tend to rise when the harvest outlook is positive and to fall after the harvest.
Ways to Trade Commodities
Trading Physical Commodities
Trading physical commodities is one way to trade in this market, by going directly to the source and buying the goods outright (such as buying oil, gold or sugar directly).
As the price of the commodity being held rises, the trader can find a buyer and pocket the difference as profit.
Trading Commodities Through Futures Contracts
A futures contract is an agreement in which the seller agrees to sell a fixed quantity of a given commodity to the contract buyer on a set day, and the buyer agrees to a fixed price for buying the underlying commodity from the seller on the contract’s expiry date.
If the commodity price rises between the purchase date and the expiry date, the trader can profit by selling the futures contract; if the price falls, the trader takes the loss on the difference.
One of the main features of trading commodities through futures is the use of financial leverage, which lets traders open large positions and buy using the funds available to them.
Trading Commodities Through Binary Options
Trading commodities through binary options is another method, similar to futures. It lets a trader take a position on the changing value of a commodity without having to buy the commodity outright.
As with futures, a trader using options contracts can also make use of financial leverage.
Trading Commodities Through CFDs
Trading commodities through contracts for difference (CFDs) is similar to trading through binary options and futures. It lets a trader speculate on the changing prices of commodities and other assets without owning the commodity in question.
Trading Commodities Through ETFs
Exchange-traded funds (ETFs) are funds that invest in a group of financial assets on the exchange. A trader can trade commodities through these funds via a broker.
ETFs are known for holding baskets of shares, but some ETFs invest in physical commodities such as gold bullion, while others invest in commodity futures or options.
One of the main advantages of trading commodities through ETFs is the diversification that comes from investing in a group of financial assets within a single fund.
Trading Commodity Shares
Commodity shares are the shares of companies that produce commodities. These companies’ revenues depend on the price of the commodity they sell: when the commodity price rises, the trader can make gains, and the company’s revenue and share price should rise as well.
Top Commodity Trading Platforms
IC Markets
IC Markets is a global broker for trading CFDs on forex.
It was founded in 2007 in Sydney, Australia, offers trading on raw spreads, and aims to serve active traders.
The company states that its goal is to close the gap between the features and tools available to individual traders and those of large institutions, creating a strong trading environment.
FXTM
FXTM is one of the better-known trading platforms.
It has attracted more than 2 million clients from 150 countries since it was founded, and it specialises in trading with financial leverage.
The platform lets traders take positions whether prices rise or fall across forex and indices, as well as commodities, shares and cryptocurrencies. As with any leveraged trading, outcomes vary and losses are possible.
Commodity Trading Costs
A trader should keep in mind that profit from commodity trading is not just the opening and closing price of a position; trading costs must also be taken into account.
When trading commodities through CFDs, there are three potential costs to consider:
Spread: the spread is the difference between the bid price (buying price) and the ask price (selling price) of the financial instrument.
Swaps: a swap fee applies when a trader keeps a position open overnight.
Commissions: some instruments charge a commission on opening and closing positions. Commissions may apply on CFDs for shares, ETFs, forex pairs and commodities.
Before you start trading commodities, study the market carefully, work out which commodities may suit your goals, and consider speaking with a qualified professional about the trading platforms that fit your needs.
Risk Disclaimer
This article is for educational purposes only and is not investment advice or a recommendation to trade any commodity or financial instrument. Trading commodities through CFDs, futures and other leveraged products carries a high level of risk, and you can lose more than your initial capital. Consider your objectives and risk tolerance, and seek advice from a licensed financial adviser before trading. Some links on this page are affiliate links: if you open an account through them we may earn a commission at no extra cost to you.
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