What is commodities trading?
Commodities are physical goods that people have been trading for centuries. They’re broadly divided in four categories: energy, metal, agricultural products and livestock. You can also see them categorised as hard or soft commodities, depending on whether they’re mined/extracted or grown/harvested respectively. Nowadays, commodities trading is done in the form of futures contracts, i.e investors agree to buy or sell at an agreed price and at a specified point in the future. Because of the way the market operates, there are two types of traders. Some actually need the underlying commodity and they use future contracts to reduce their exposure to price volatility. Others want to speculate on the price of the commodity with a view to making a profit but they will never want to take ownership of the commodity itself.
All commodities are valued in USD and the smallest possible price change is called a tick. How much a tick is worth, depends on the commodity, e.g. in gold or oil trading a tick is worth $0.01 whereas in soy beans trading a tick is worth $0.25. Another detail to note when you trade commodities, is that each one comes with its own unit, e.g. the smallest quantity of oil you can buy is a barrel whereas the smallest quantity of gold you can buy is an ounce.
So how do I get involved in commodities trading?
If you want to trade futures contracts directly, you need to explore the best commodity trading platforms and find one who offers this service. You can, however, invest in the commodities market indirectly via ETFs or stocks of companies related to the instrument you’re interested in.
Some commodities, e.g. gold, are considered a relatively safe investment whereas others, e.g. oil, are volatile which means there’s huge opportunity for profit. As with all investment, you need to understand the basic factors that drive price changes and trade accordingly. In the case of commodities, the main thing to watch out for is supply and demand, which can be affected by things like seasonality, weather and geopolitical factors . Let’s use oil as an example: the biggest consumption happens in countries like the U.S., U.K, Germany, Japan and China. So, when people in these countries are experiencing a particularly cold winter or when they’re about to drive away for their summer vacation, demand will increase with a subsequent increase in price. The U.S. Department of Energy publishes a weekly inventory which gives you an idea of what to expect. Then you need to factor in supply. OPEC publishes a report which covers demand, as well as supply, production and forecasting. The interesting thing here is that OPEC controls supply so they can produce more when demand is high, thus lowering the price. Or not. OPEC is very powerful when it comes to controlling the price of this valuable commodity but the drive towards renewable energy sources may change this.
Online brokers offer leverage on commodities trading. This means that you can open a large position, which you wouldn’t otherwise be able to afford based on your account balance. E.g. if a broker offers 100:1 leverage on oil, you can open a position and only pay 0.1% of its value.
Bitesize basics
- Commodities are physical goods that people trade in the form of futures contracts.
- Commodities trading attracts both investors who actually want the underlying goods and speculators who want to profit off price fluctuations.
- The price of commodities will change depending on supply and demand, geopolitics, weather and seasonality.
- You can buy on margin and benefit from leverage to hold a position you wouldn’t otherwise be able to afford.
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