Investing in commodities is not just about trading goods; it’s about understanding the world’s heartbeat and turning global trends into personal triumphs.

Commodity trading has been around for longer than we can imagine, and it continues to impact our lives in several significant ways today. Among these, we can count the role it plays in global trade, economic growth and the price of consumer goods.

Besides the impact it has on the global economy, commodity trading offers plenty of investment opportunities to investors and institutions around the world. This article will explore what commodities are and provide an overview of how you can trade them in the global market.

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What Are Commodities?

Commodities are raw materials or primary agricultural products that can be bought and sold. Encompassing a wide range of physical goods from oil and gold to wheat and coffee, they are the building blocks of the global economy.

Types of Commodities

There are mainly 3 types of commodities that are traded on global exchanges.

1. Metal Commodities

Metal commodities include precious metals and industrial metals.

Precious Metals: Among precious metals, we can count gold, silver, platinum, and palladium. These are often seen as safe-haven assets, providing a hedge against inflation and economic uncertainty. They are used in jewellery, electronics, and as valuable assets that are kept for investment purposes.

Industrial Metals: These include copper, aluminium, zinc, nickel, and lead. Industrial metals are essential for construction, manufacturing, and various industrial processes. They are used in building infrastructure, electrical wiring, and the production of machinery and vehicles.

2. Energy Commodities

Energy commodities are crucial for powering the world. They include:

Crude Oil: One of the most traded commodities, crude oil is refined into products like gasoline, diesel, and jet fuel. It is essential for transportation, heating, and the production of chemicals and plastics.

Natural Gas: Natural gas is used for heating, electricity generation, and as industrial feedstock. It is considered a cleaner alternative to coal and oil.

3. Agricultural Commodities

Agricultural commodities are essential for food production and they include:

Grains and Cereals: Grains and cereals are food products such as wheat, corn, rice, and barley. These are staple foods for human consumption and feed for livestock.

Soft Commodities: Soft commodities include coffee, cocoa, sugar, and cotton. These are grown primarily in tropical and subtropical regions, and are used in a variety of food products, beverages, and textiles.

The Commodity Market

The Commodity Market

Think of the commodity market as a global marketplace where commodities are traded. With a history that dates back thousands of years, it has evolved from simple barter systems to sophisticated global trading platforms.

Thanks to the commodity market, countries can leverage their natural resources, create jobs and foster economic growth. This is because commodities are fundamental to industries like agriculture, energy, technology, manufacturing and food.

But how does the commodity market work when it comes to individual investors who simply want to hedge, diversify their portfolio, or speculate on market opportunities?

How Commodity Trading Works

On the one hand, commodities are traded physically by producers, manufacturers, retailers, wholesalers and government entities. On the other hand, they are traded through their financial derivatives by individual investors, hedge funds, banks and other financial institutions.

When trading derivatives, commodities may or may not be physically exchanged. Here are the primary ways in which that works:

Futures Contracts

These are standardised contracts to buy or sell a specific quantity of a commodity at a predetermined price on a future date. Futures trading is one of the most common methods of trading commodities.

Options Contracts

This involves buying options contracts that give the trader the right, but not the obligation, to buy or sell a commodity at a set price before a specified date. Options provide flexibility and are used in hedging and speculation.

Exchange-Traded Funds (ETFs)

ETFs that track commodity prices offer a way to invest in commodities without directly trading futures contracts. These financial instruments trade on stock exchanges and provide exposure to commodity price movements.

Commodity Stocks

Investing in stocks of companies involved in the production, extraction, or processing of commodities is another way to gain exposure to commodity markets. For example, buying shares in a gold mining company can give you the opportunity to profit from the price changes in the gold market.

Contracts for Difference (CFDs)

CFDs allow traders to speculate on the price movements of commodities without owning the physical asset. They are leveraged products, which means that traders can control a large position with a relatively small amount of capital. This allows traders to amplify the outcome of their trade. In other words, their profits and losses end up bigger than what they would have been with the trader’s invested capital alone.

At XM, we offer commodities through CFDs on futures giving you the flexibility to speculate on the price movements of your commodity of choice without physically owning it.

Through CFD trading, you have the option of not only buying a commodity with the aim of selling it for a higher price but also selling it with the aim of buying it at a lower price, giving you the possibility of profiting from both rising and falling markets. Additionally, as mentioned above, you can choose to use leverage which would amplify your potential profits; but, you should keep in mind that it would also enlarge your potential losses.

Are you curious about how it works? Let’s go over a commodity trade example to help you form a full picture.

Example of A Commodity Trade

Cocoa CFD Trade Example

Suppose that the current price of cocoa is $2,400 per metric ton. You have an investment capital of $2,400 and you believe that cacao prices will soon go up. You decide to trade CFDs on cocoa with a leverage of 10:1.

With your investment capital and the leverage you are using, you can control a position worth $24,000 ($2,400 * 10). This means that you can buy 10 metric tons of cocoa ($24,000 / $2,400 per metric ton).

You open a long (buy) position on 10 metric tons of cocoa using a CFD trading platform at the price of $2,400 per metric ton.

Scenario A – The Market Moves in Your Favour

The price of cocoa rises to $2,500 per metric ton. Your position is now worth $25,000 (10 metric tons * $2,500 per metric ton).

You decide to close the trade and realise your profit.

In this case, the profit you make is $1,000 ($25,000 – $24,000).

Scenario B – The Market Moves Against You

The price of cocoa falls to $2,300 per metric ton. Your position is now worth $23,000 (10 metric tons * $2,300 per metric ton).

You decide to close the trade and limit your losses.

In this case, you end up with a loss of $1,000 ($24,000 – $23,000).

What Moves Commodity Prices?

What Moves Commodity Prices

As with many things, commodity prices go up and down as a result of the interplay between supply and demand.

Supply

Commodity supplies can be impacted by agricultural yields, mining output and energy production. It is a factor that is not easy to put into the equation when it comes to commodities as it can be affected by unpredictable occurrences such as natural disasters and geopolitical events. For instance, extreme weather conditions or sanctions on oil-producing countries can limit supply and drive oil prices up.

Demand

Economic growth, consumer trends, and industrial usage, on the other hand, are the driving factors behind demand. For example, increasing demand for electric vehicles can boost demand for metals like lithium and cobalt, making them more expensive.

Understanding these factors helps traders and investors make informed decisions in the commodities market, anticipating price movements and managing risks effectively.

Why Should You Trade Commodities?

Commodity trading offers several advantages that can make it an appealing option for investors. Here are some key reasons why you could consider trading commodities:

Diversification

Commodities provide diversification in an investment portfolio, reducing risk by spreading investments across different asset classes.

Hedging Against Inflation

Inflation erodes purchasing power and leads to higher commodity prices. This is why commodities often serve as a hedge against inflation.

Liquidity

Many commodity markets are highly liquid, allowing traders to enter and exit positions easily.

Speculative Opportunities

The volatility in commodity prices offers numerous opportunities for speculative trading and potential profits.

Commodity Trading Risks

As we touched upon earlier, when it comes to commodities, supply and demand are affected by events that can be hard to predict. This is why commodities are high-risk assets. Here are the risks to consider before beginning to trade:

Volatility

Commodity prices can be highly volatile, influenced by a wide range of factors including geopolitical events, weather conditions, and economic data.

Leverage

Trading on margin or using leveraged products like CFDs can amplify both gains and losses.

Market Dynamics

Understanding the supply and demand dynamics of each commodity market is crucial. Factors such as production rates, technological changes, and government policies can impact prices.

How to Manage Risk When Trading Commodities

Risk management is crucial when trading commodities due to the inherent volatility and leverage involved. Here are some key strategies to follow:

  1. Calculating your risk-reward ratio
  2. Setting stop-loss and take-profit orders
  3. Diversifying your portfolio
  4. Using leverage cautiously
  5. Staying informed about changes in the market
  6. Having a clear trading plan
  7. Regularly reviewing your performance and adjusting your strategy
  8. Maintaining emotional discipline

Final Thoughts

Commodities will always have a place in our lives, and their volatility, stemming from a wide range of factors that move the commodity market, makes them into high-risk assets while also being the very thing that makes them attractive to investors looking for opportunities. Investing in commodities is not just about trading goods; it’s about understanding the world’s heartbeat and turning global trends into personal triumphs.

You can consider trading commodities through CFDs if you would like to have exposure to the commodity market without owning the underlying asset. This would allow you to amplify your position size with the use of leverage, though you should note that this magnifies losses as well as profits. Additionally, you would be able to profit from both rising and falling prices in the market through going long and short.

That being said, understanding the fundamental and technical aspects of commodity markets is essential. While the potential for profit is significant, it is equally important to be aware of the risks involved and to develop a sound trading strategy.

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Frequently Asked Questions

1. What is the most traded commodity in the world?

The most traded commodity in the world is crude oil. It is a crucial energy source and a key input for various industries, making it highly demanded. Crude oil’s significance in transportation, manufacturing, and energy production drives its extensive trading in both physical and derivatives markets.

2. Which commodities are best for trading?

The best commodities for trading often include crude oil, gold, silver and natural gas. This is due to their high liquidity and significant price movements which are influenced by global economic factors. Crude oil and natural gas are essential energy sources with volatile prices, while gold and silver are popular for hedging against economic uncertainty.

3. Are commodities a good investment?

Commodities can be a good investment because they offer diversification, act as a hedge against inflation, and can provide potential for high returns due to price volatility. However, they also carry risks such as market volatility, geopolitical influences, and changes in supply and demand. The suitability of commodities as an investment depends on an individual’s risk tolerance, investment goals, and the ability to monitor and understand commodity markets.

4. How can I start trading commodities?

Opening an account with a global broker is the first step to beginning your journey in the commodity market. Here are a few pieces of advice for those who are just starting out:

  • Educate Yourself: Learn about different commodities, how their markets work, and the factors influencing their prices.
  • Conduct Research: Analyse market trends, economic indicators, and geopolitical events to make informed trading decisions.
  • Use a Demo Account: Try out your strategies on a demo account before using them in a real trading environment.
  • Start Small: Begin trading small positions to gain experience, and gradually increase your exposure as you become more comfortable.
  • Monitor and Adjust: Continuously monitor your trades and adjust your strategy based on changing market conditions and your performance.

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