What Is Commodity Trading And Why Is It So Important To Traders?

Commodity is the oldest form of financial instruments. Commodities’ market is almost as old as human civilization itself.

August 06, 2021 - 03:06 PM 575 views

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Highlights: 

  • Commodities that are traded are typically sorted into four categories broad categories: metal, energy, livestock and meat, and agricultural.
  • For investors, commodities can be an important way to diversify their portfolios beyond traditional securities.
  • In the most basic sense, commodities are known to be risky investment propositions because their market (supply and demand) is impacted by uncertainties that are difficult or impossible to predict, such as unusual weather patterns, epidemics, and disasters both natural and human-made.
  • There are a number of ways to invest in commodities, such as futures contracts, options, and exchange traded funds (ETFs).

Commodities are an important aspect of most American's daily life. A commodity is a basic good used in commerce that is interchangeable with other goods of the same type. Traditional examples of commodities include grains, gold, beef, oil, and natural gas.

For investors, commodities can be an important way to diversify their portfolios beyond traditional securities. Because the prices of commodities tend to move in opposition to stocks, some investors also rely on commodities during periods of market volatility.

In the past, commodities trading required significant amounts of time, money, and expertise, and was primarily limited to professional traders. Today, there are more options for participating in the commodity markets.

Commodity is the oldest form of financial instruments. Commodities’ market is almost as old as human civilization itself. Historical evidence suggests that rice might have been the 1st commodity around 6,000 years ago. In times of Sumerian civilization (4,500 BC) people used clay tokens as a form of money to buy livestock. Commodities have become a popular means of inflation hedging and portfolio diversification. For many traders and investors, commodity trading is a preferred way to protect funds and reduce the overall risk for their portfolios.

What are the major commodities?

Generally, commodities can be divided into four main categories:

  • Agricultural commodities, including food crops (cocoa, cotton, corn, coffee, etc.), livestock (hogs, cattle) and industrial crops (including wool and lumber).
  • Energy commodities, including natural gas, crude oil and gasoline, coal and uranium, ethanol and electricity. 
  • Metal commodities, including base metals (i.e. iron ore, zinc, aluminum, nickel, steel, etc.) and precious metals (gold, silver, palladium and platinum).
  • Environmental commodities, including renewable energy certificates, carbon emissions and white certificates.

Some believe that cryptocurrencies – unique and extremely popular asset class – can be also referred to as commodities. Though the Swiss Financial Market Supervisory Authority (FINMA) and the US Securities and Exchange Commission (SEC) tend to regulate cryptocurrencies as something akin to shares, many consider real-world commodities as a much better analogue for crypto.

Proving this theory, Bitcoin is referred to as “digital gold” and many cryptocurrencies are “mined”. In the core essence, cryptocurrencies, the same as commodities, are free from outside control and their values are defined by market factors. Besides, cryptocurrencies can be also traded for goods and speculated upon. Having said all this, let’s put them here:

  •  Cryptocurrencies, including Bitcoin, Litecoin, Ethereum, Ripple, Monero, and many others.

Why trade commodities

There are several major reasons to trade commodities:

Diversification

The presence of commodities in an equity-only portfolio can lower the volatility due to the absence of a direct correlation between commodities and other asset classes.

Safe haven

Commodities can serve as a safe haven in times of global economic uncertainty and market turbulence, because they can retain their physical value.

Inflation hedging

Commodities’ intrinsic value is independent from currencies. They will often hold their value, even if a currency falls during a period of inflation.

Speculation on commodities prices

Commodities may be highly volatile, experiencing wild price swings. Trading commodities CFDs is one way to try and profit from significant price fluctuations.

Commodity trading requires careful consideration due to the market’s occasional high volatility and a wide choice of available instruments, from derivatives such as futures and CFDs, to commodity-producing companies’ stocks.

With commodities, the chance of making large profits goes hand in hand with the risk of large losses. Commodity price may be very challenging to predict. The price can change abruptly due to several factors, such as weather, political unrest and labour strikes. Unlike with stocks, there are almost no fundamental financial metrics, such as price/earnings ratios, interest rates, etc.

How to trade commodities CFDs

One of the easiest and most popular ways to trade commodities is with CFDs. A contract for difference (CFD) is a type of contract between a trader and a broker in order to try and profit from the price difference between opening and closing the trade.

Investing in commodity CFDs saves you the inconvenience of paying for commodities storage, in case of physical delivery. Using CFDs to trade commodities will allow you to go long or short without having to deal with conventional commodities exchanges, like CME, ICE or NYMEX.

In addition, CFDs give you the opportunity to trade commodities in both directions. No matter whether you have a positive or negative view of the commodity price forecast, you can try to profit from either the upward or downward future price movements.

Moreover, commodities trading through CFDs is often commission-free, with brokers making a small profit from the spread – and traders trying to profit from the overall change in price.


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