The commodities markets are one of the key markets in the global world of trading. Commodities trading, as the name suggests it is nothing but trading of frequently used materials. Trading commodities can be lucrative and offers a variation to the regular financial markets such as equities or currencies.
Unlike other markets, to be successful in trading commodities, you need to have in-depth knowledge about the commodities that you trade. Understanding what drives the commodity prices and the mechanics behind it can help you to maneuver the dynamic commodities market successfully.
In this article, we take a look at what it takes to trade commodities and what you should know to be successful in the commodity markets.
What are commodities?
Commodities are nothing but the basic goods, mostly raw materials used in commerce. Commodities are traded daily and can span a variety of industries.
For example, the oats that you probably consume is nothing but a commodity. Oats are one type of commodity that you can trade. The main difference between commodities and other goods is the standardization and the interchangeability with products of a similar type.
In many cases, two equivalent units of the same commodity will have a stable price anywhere in the world.
Commodities can be grown, produced, mined and traded. Most of the commodity markets are very liquid, and they offer a way for producers and consumers to transact efficiently.
The advent of commodities trading began since the start of human civilization. Rice is the first traded commodity some 6000 years ago in China.
However, if you go further back in history, you will find that there were many other commodities such as livestock that were traded.
The commodity markets as we know it today started to evolve in the United States around the 19th century. Commodities trading began as an answer to the consumption needs of the nation. As the years progressed, commodities markets became more standardized with the rest of the world following suit.
The U.S. Commodity Futures Trading Commission, known as CFTC started to regulate the commodity markets since 1975. The commission shaped after the establishment of the Commodities Exchange Act of 1936.
Type of commodities
When you talk about currency markets, for example, you know that the markets deal with the currencies and the exchange rates. Similarly, when one talks about equity markets, you know that the market deals with trading of shares in companies.
With commodities, however, there are different categories. Therefore, the term commodity trader or commodity trading is merely a broad and vague term.
Below read more about the most commonly traded commodities in the world.
Agricultural commodities: These commodities include trading of food such as corn, soybeans, wheat. Livestock also falls into this category and includes cattle, hogs, pork bellies. Finally, you also have industrial crops such as cotton, lumber, rubber, and wood to name a few.
Energy commodities: As the name suggests, energy commodities deal with products such as crude oil, gasoline, natural gas, heating oil, coal, and similar products.
Metal commodities: The metals commodities include a mix of precious metals such as gold, silver, platinum and base metals such as aluminum, copper, steel, and iron as some examples.
Depending on the type of commodity you trade the terms are different. Also, the fundamentals that determine the commodity type you trade can vary. Therefore, despite the fact that the term commodity describes the commodity markets, it can be categorized into specific products.
Where can anyone trade commodities?
Commodities are standard products, and therefore they are traded at an exchange. However, unlike exchanges such as the New York Stock Exchange or NASDAQ, commodity assets trade at a specialized exchange known as the commodity exchange.
Examples of commodity exchange include the CBOE (Chicago board of exchange) or the NYMEX (New York Mercantile Exchange). Commodities are primarily traded as futures. The exchanges are also known as futures exchange.
The futures markets are centralized, and the commodity assets are standardized. You can buy and sell the commodity futures and hold the contract until delivery or sell the contract before delivery.
Commodity futures roll over four times a year in the March, June, September and December quarters.
Although the commodity markets are standard, depending on the type of commodity you trade the terms can vary. For example, one standard contract in the oil markets is not the same as one standard contract of oat futures.
How does the commodity trading markets work?
The commodity markets determine the price of all traded commodities on the exchange. Therefore, it is entirely possible that the cost of items that you use daily are already set at an exchange. The price of commodities can vary from day to day.
An example of this is the gold prices which are volatile and change by the hour.
Dealers in commodity securities trade at an exchange. Due to the volatility in the commodity prices, producers and consumers transact to lock in on a price.
Some of the significant participants in the commodity markets are the producers. Producers can be farming houses and other institutions that deal with the production of the commodity. On the other hand, consumers are those firms that buy the raw material for further processing.
Trading commodity futures basically to hedges the exposure to the price volatility. Using the futures contracts, both producers and consumers can agree on a price for a future date of delivery. This will allow both the producers and the consumers to lock in on a price instead of the uncertainty due to the volatility in prices.
How can you trade commodities?
There are many ways that one can trade the commodity markets. We already covered how futures can be used to trade the commodity markets. As speculators, you can engage in buying and selling of contracts.
The only difference is that instead of holding the contract until delivery, you can sell the contract before the delivery and thus settle financially.
Besides commodity futures, you can also trade commodity CFDs. CFDs, also known as contracts for difference, count as speculative instruments. You do not own the underlying security or asset but use the CFDs to only speculate on the price volatility.
Many day traders prefer the use of commodity CFDs as it frees them from the hassles of rolling over the contracts which is a requirement in the futures markets. Secondly, commodity CFDs can be traded on margin which is another appealing factor for most traders.
Some of the commonly available commodity CFDs are Oil (WTI and Brent), Gold and Silver, Coffee, Sugar, Coca, and Natural Gas. Each of these commodities has a different contract size and other related expenses.
Commodities trading – In summary
In conclusion, commodities trading offers a good variation from the more popular stocks and currency markets. Trading commodities as CFDs offers quite a few benefits for traders as it allows you to trade on leverage.
From a trading perspective, commodity CFDs are a great vehicle to speculate on the price volatility. Commodities show strong trends that can last over the years and offers an exciting approach for trend traders.