Every investor wants a well-diversified portfolio, and with a recent boom in the world of cryptocurrencies, there is a visible increase in the need and desire for commodity trading.
However, not every investor realizes the importance of investing in commodities and the benefits that commodity trading has to offer. Since commodity trading involves the buying and selling of natural resources like wheat, sugar, precious metals, fossil fuels, and many more. That being said, we bring you a brief overview of the beginner’s guide to commodity trading.
The two main types of commodities are hard and soft commodities. Soft commodities are those that are grown in nature, such as sugar, corn, coffee, cocoa, soybean, wheat, fruit, livestock, and others. Hard commodities mostly include those natural resources that need to be extracted in some form. These include commodities such as gold, silver, platinum, oil, rubber, and others.
Most of the commodities are traded on numerous exchanges that specialize in specific markets, such as the London Metal Exchange, which specializes in non-precious metals, and the Chicago Mercantile Exchange, which specializes in energy and metals. You can always check live commodity prices on Capital.com, where you can trade commodities CFDs that provide greater liquidity and the ability to trade on leverage, which can amplify your wins as well as your losses.
Speaking of the most popular commodities, the ones that should definitely be mentioned include crude oil, corn, gold, natural gas, Brent oil, silver, copper, cotton, soybeans, and many more. Unlike the stock market, the commodity market is open 24/7.
That being said, commodity trading can be extremely risky and unpredictable. However, it can also fetch larger and faster gains, since the reward is always higher where the investment risk is high as well. Trading commodities is, usually, a short-term investment, especially if the futures contract comes with an expiry. For long-term investments, investors are way keener on investing in the classic stock market.
As the supply and demand for commodities constantly change, the prices of the commodities will also change. Commodity prices always tend to rise with increasing demand. Their prices will also rise if there is a fall in the overall supply or deficiency in the inventory of a particular commodity. On the other hand, the price of a commodity will equally fall if it is faced with a decrease in demand and an increase in supply.
Since commodities are generally priced in USD, their price also tends to fall if the value of USD rises. The same goes the other way around- if the price of USD falls, the price of commodities will usually rise. For example, if the USD experiences a sharp rise against other major currencies, this could mean we could see a fall in the prices of commodities. Of course, markets do not always operate so uniformly, but such external factors should always be considered when getting into commodity trading.
There are several different ways to trade your commodities, so we bring you some of the most popular ones:
Commodity futures are, usually, the most common way to trade commodities. Using the futures contract, the investor tries to make an agreement with another investor regarding the future price of the commodity.
Investors need to set up a specialty broker account to invest in futures trading that enables future and options trades. Once they do, the brokerage company levies a commodity future trading commission whenever the investor opens or closes a position.
In the previous example of futures contracts, investors are not actually buying or selling the real commodity itself. They are actually betting on the price changes of these commodities. However, when it comes to precious metals, investors can actually possess physical commodities like gold, silver, platinum, and many more. These possessions usually come in the form of gold or silver bars, jewelry, coins, and other different variations of precious metals.
While trading physical commodities allow you to feel the actual weight of your investments, precious metals are often associated with transaction costs higher than other investment options. Investing in physical commodities is only practical and profitable if there are value-dense commodities involved. Even then, investors need to pay expensive markups on top of the spot price available in the retail market.
The third way to trade commodities is to buy the stock of a company that deals in that particular commodity. For example, if you wish to invest in oil, you can buy stocks of an oil refining company. The stocks of these companies mostly follow the price of the actual commodity so, theoretically, if the oil gets a spike in its price, an oil company will usually be profitable as well. As a result, its stock price should go up too.
Investing in stocks is, mostly, less risky than investing in the commodity directly since you are not betting your entire money on one commodity price. Also, a well-established company can still make profits even if the price of the commodity they are dealing in is going down.
This could, of course, end up either way. Even though a spike in oil prices can make an oil company’s stock price rise as well, its internal management and total market share are also very important factors to consider.
Commodity trading usually attracts more prominent and sophisticated investors than your average crypto investor. Since the shifts in commodity prices can lead to enormous profits and losses, investors should surely be prepared to take the extra risk before investing in commodities. They need to be okay with facing short-term losses while aiming for long-term gains. Even if investors decide to trade in commodities, they should most definitely allocate only a portion of their entire portfolio for commodity trading.
As we already said, there are many factors that play a part in determining the prices of commodities. Some of these factors are predictable, such as government policies. On the other hand, factors like nature itself are always unpredictable, while they directly affect the state and quality of many different commodities.
It is important to accustom yourself to all of the major factors, such as those listed above. You will find yourself to be more prepared when trading in the commodity market. Also, you should never invest money you are not ready to lose and always do your own research before making any kind of investment.