Improve your success in the financial markets by learning how to trade commodities.
Investing in commodities via trading is a common strategy that involves buying and selling raw materials or primary agricultural products.
From gold and oil to coffee and wheat, there is an infinite number of opportunities for traders to reap profits in the commodity market.
In this article, we will be discussing the main aspects of how to trade commodities, explaining the main concepts, giving some examples, and presenting the top 10 commodities to trade.
Whether you are a beginner or an expert looking to improve your skills in the stock market, this guide will help you understand how to navigate the exciting stock market and improve your trading skills.
How to Trade Commodities: Understanding the Basics
So let’s start with the basics. What are commodities? Well, commodities are basic goods used in commerce that are fungible – interchangeable with other goods of the same type.
While the specific quality of a given commodity will differ (as in all things), it is generally uniform across producers.
Commodities are traded on exchanges, which are markets for commodities where supply and demand dictate prices.
The Size of the Commodities Market
Commodities are the largest financial market in the world. Daily trading volume reaches trillions of dollars, providing traders with deep liquidity and opportunities to buy and sell at any time.
It’s an exciting, fast-paced market where you can speculate on the movements in the prices of raw materials and agricultural goods around the world.
How to Trade Commodities: Key Terms You Need to Know
1. Commodity
A commodity is a basic good used in trade that, at least in principle, can be replaced by a good of the same or similar type.
Examples include metals such as gold and silver, as well as energy products such as oil and natural gas, and agricultural products such as wheat and coffee.
Real-Life Application
You might believe that the price of gold will rise because of economic uncertainty: in that case, you might trade the commodity to benefit from the anticipated price rise.
2. Futures Contract
A futures contract is an agreement to buy or sell a contract at a fixed price on a certain date in the future.
Futures contracts are used to speculate on the future direction of prices in a commodity market.
Real-Life Application
For example, if you feel that the price of crude oil will go up in six months, you can buy a crude oil futures contract; if you’re right, you can sell it for more than you paid for it.
3. Spot Market
The spot market is where commodities are exchanged for immediate delivery. The spot price is the current market price at which a commodity can be bought or sold for immediate delivery.
Real-Life Application
For example, if you want to buy a large amount of coffee beans for immediate use, you would buy them on the spot market at the spot price.
How to Trade Commodities: Getting Started
Choosing a Broker
Your next step is to choose a broker with a good track record, low spreads, and a solid trading platform.
Also, make sure the broker is licensed with a reputable financial regulator whose supervision will ensure the safety of your funds.
Opening a Trading Account
Once a broker has been selected, you will have to open your trading account. You will be required to provide certain personal information, verify your identity and fund the account.
Most brokers offer demo accounts where you can trade with virtual money before you start investing real money.
Developing a Trading Strategy
To be consistently successful, you’ll need an effective trading strategy.
This should include describing the entry and exit points for trades, the risk management rules you’ll follow, and the type of analysis you’ll perform – whether that’s technical analysis (based on price charts and patterns), fundamental analysis (based on economic indicators and news events), or a combination of the two.
How to Trade Commodities: Top 10 Commodities to Trade
1. Gold
Gold is the world’s most heavily traded commodity and is often referred to as a ‘safe-haven’ asset: Investors buy gold when they are worried about the economy. It is used as a hedge against inflation.
Real-Life Application
Should interest rates become unstable, or should the price of consumer goods rise, you may exchange gold to protect your other investments if they lose value.
2. Crude Oil
Crude oil is one of the main energy commodities in the world. It plays an important role in the world economy. The price of crude oil depends on the geopolitical situations, the supply and demand, the OPEC decisions, and so on.
Real-Life Application
If, for instance, there is political tension in an important oil-producing region, you might expect that crude oil prices – and the prices of futures contracts on crude oil – will increase, so you could trade oil futures to make money from this upward movement.
3. Silver
Silver is the third of the precious metals whose trading in the commodities market dominates.
It has industrial applications and value, the latter of which is somewhat more stable than some commodities.
Real-Life Application
If you think that industrial demand for silver will rise, for example, you might trade in silver to capitalize on the anticipated price increase.
4. Natural Gas
Natural gas is an important source of energy to generate heating, electricity, and industrial processes. The price is determined by weather conditions, supply and demand, and economic activities.
Real-Life Application
In winter, demand for natural gas is typically higher than in other months. You could speculate on a seasonal price increase by trading natural gas futures.
5. Copper
Copper is one of the most widely used metals in construction, electronics, and manufacturing, and so its price is a reliable indicator of health in these sectors, which are the main drivers of economic activity.
Real-Life Application
For example, if you expect economic growth in poor countries, you might buy copper because more infrastructure is likely to cause demand and prices to increase.
6. Wheat
Wheat is an agricultural commodity and a staple food whose prices are sensitive to the weather, crop yields, and global demand, and a large amount of which is traded in agricultural markets.
Real-Life Application
If there is a prediction of bad weather in the major wheat-producing areas, you might sell wheat futures, expecting a shortage in supply and a rise in price.
7. Corn
Corn is another important staple crop. It is used in food, animal feed, and biofuels. Its price depends on planting acreage, weather, and government policies.
Real-Life Application
If a government announces subsidies for the production of biofuels, you might buy corn futures, betting that this will drive up demand for corn as a feedstock for biofuels.
8. Coffee
Coffee is a global commodity, with prices driven by weather, geopolitics, and demand. It trades across the world in a volatile market.
Real-Life Application
For example, if there is a report of bad weather in the major coffee-growing regions, you might bet on coffee futures, expecting supply disruptions to send prices higher.
9. Soybeans
Soybeans are used in food, animal feed, and biofuel. Prices are a function of planting decisions, weather, and trade policy.
Real-Life Application
You might trade soybean futures, betting on price swings related to, say, a geopolitical dispute between the dominant soybean producer and importer countries.
10. Platinum
Platinum is a precious metal used as a catalyst in automotive catalytic converters, as well as in jewellery and industrial uses. Its price is governed by industry demand and mining production.
Real-Life Application
If car production increases, you might sell platinum, expecting increased demand for catalytic converters and thus higher prices.
How to Trade Commodities: Analyzing the Market
Technical Analysis
Technical analysis is utilized by those who believe that the market’s price behaves predictably and relies on reading price charts and using indicators (such as moving averages, the relative strength index [RSI], and Fibonacci retracements) to anticipate what will happen next.
Real-Life Application
Should you spot gold forming a ‘head and shoulders’, this might lead you to predict a trend reversal, and you could place a trade to capitalize on the anticipated movement in price.
Fundamental Analysis
In fundamental analysis, economic indicators, political events and general sentiment towards a commodity are examined to derive its value. Indicators include gross domestic product (GDP), employment rates, weather, and so on.
Real-Life Application
If the US Department of Agriculture releases figures showing that corn yields will fall below expectations, you could buy corn futures, expecting prices to rise because of falling supply.
Sentiment Analysis
Sentiment analysis measures the emotions of market participants. Tools such as the Commitment of Traders (COT) report and social media sentiment could be used to predict market trends.
Real-Life Application
If sentiment gauges reveal that traders are too bullish on crude oil, it could be a sign that what goes up must continue on its upward path.
How to Trade Commodities: Managing Risk
Setting Stop-Loss and Take-Profit Orders
Stop-loss orders are orders that close a trade automatically if it falls to a level that you have predetermined. Take-profit orders are orders that close a trade automatically if it rises to a level you have predetermined.
Real-Life Application
If you buy a crude oil futures contract at $50 per barrel, you would put in a stop-loss order to sell at $48 per barrel to keep losses small, and a take-profit order to sell at $55 to lock in your profits.
Position Sizing
Position sizing is the percentage of your trading capital that you should risk on any one trade. A common rule is that you should never risk more than 1-2% of your trading capital on any one trade.
Real-Life Application
With a trading account of $10,000, for example, you’d set your risk per trade to 2%. In this case, that would mean risking $200 per trade. You’d be keeping your risk in check and protecting your capital.
Diversification
By diversifying your trades across a range of commodities, you can minimize your risk. If you spread your available capital across numerous trades, an adverse move in the market on one trade is unlikely to result in a catastrophic loss.
Real-Life Application
You would trade not just gold, but also crude oil and wheat to diversify your risk.
How to Trade Commodities: Staying Informed
Keeping Up with Market News
Commodity traders typically need to stay abreast of international market news and economic events to make informed trading decisions.
Economic calendars and news websites are a great way to learn about upcoming key events that could affect commodity prices.
Real-Life Application
If an economic calendar informs you that a meeting of the Organization of the Petroleum Exporting Countries (OPEC) is coming up, you might take that into account and change your trading strategy – since what happens at the meeting will increase the prices of oil.
Continuous Learning
The commodities market is never static and eternal learning is vital for long-term success. Watch webinars, read books, and join trading communities.
Real-Life Application
Attending free webinars that traders host can help you learn new strategies or get tips on how to trade.
