A detailed guide to commodity trading for beginners

Commodities are a basic and most essential part of everyday life for everyone. All of us need one or the other kind of commodity to live and survive. To eat, we would need agricultural and livestock commodities like grains, meat, etc., most of us cannot start our days without a good cup of coffee. Therefore, commodities exist as a crucial part of our daily lives. A commodity is any good that can be exchanged for the other goods. For investors and traders, commodity trading can prove to be one of the fairest ways to diversify the portfolio and mitigate risks concerning other securities and instruments in the league.

The reason commodities tend to protect and safeguard portfolios is that they move in the opposite direction of conventional instruments like stocks. During the period of high volatility in the market, many investors turn to commodity trading.

In the past years, commodity trading was a complicated affair as it required a lot of capital, funds, efforts, and time. Only professionals and experts were able to make it to the commodities. In current times, commodity trading has become more accessible to all kinds of traders and investors.

History of commodity trading

Unlike bonds or stocks, which are relatively new concepts, Commodity trading entails a history that goes back to ancient times. Many empires were birthed and came into being due to the creation of complex commodity exchange systems.

In current times, commodities are still traded and exchanged globally. The commodity can either be a physical place or location where commodities are traded or to legal institutions or entities that are responsible for facilitating regulated and standardised commodity trade.

A lot of mergers have taken place in recent years. Many major exchanges entail a lot of commodities, while others focus on just one specific type. Some significant exchanges include the New York Mercantile Exchange, the London Metal Exchange, the Chicago Mercantile Exchange, the Intercontinental Exchange, etc.

Principles of commodity trading

The most straightforward and basic principles of demand and supply operate with commodity trading. So when the supply of a particular commodity is less in the market, the demand for the underlying commodity increases. Since there is low supply, hike in the price of a commodity can be witnessed. Therefore, low supply due to bad weather, unstable economic conditions, etc. Can lead to increase in demand and in turn, increase in prices.
On the other hand, when supply is more generous than demand, the commodity price will decrease in the market.

Types of commodity

Commodities are categorised into four basic types:

Metal

Silver, Gold, Copper, and Platinum are included in the metal category of commodities. During the bearish and highly volatile market conditions, many investors can turn up to investing in precious metals. Most of the time, traders and investors would go to gold in such a situation. The reason being its reliable and trustworthy status and convertible value. Many investors also perform hedging functions through such metals during extreme inflation or currency devaluation.

Livestock and Meat

Another category in kinds of commodities is livestock and meat. It includes commodities like hogs, feeder and live cattle, and pork bellies.

Agriculture

Agricultural commodities include a wide range of products like cocoa, coffee, wheat, soybeans, rice, cotton, and sugar. Trading agrarian commodities can prove to be highly volatile during months of weather-related changes. The limited supply of agricultural products and high population growth can serve as significant factors for traders to go with such commodities.

Energy

Energy commodities include heating oil, natural gas, crude oil, and gasoline. Due to the global development of the economy, the oil output from many wells has decreased. This has kindled high prices in the market. Simultaneously, alternative energy sources like solar energy, biofuel, and wind power can witness a rise in demand. Such energy sources aim to substitute crude oil as the core source of energy.

Commodity trading with futures

One subtle way to trade and invest in commodities is through futures contracts. A futures contract is a legal contract to exchange a particular commodity at a preset price at a fixed time in future.

The buyer now has an obligation to receive the commodity in the picture as and when the contract reaches the expiration date. The seller, therefore, has the responsibility to provide the commodity to the buyer on that date. Futures contracts can be exchanged for every kind of commodity in the market.

Several advantages are associated with trading futures contracts. They lead to more precise and more effortless analysis because it is an unmixed take on the underlying commodity. It is typically easy to carry both short and long trading positions through futures contracts. There is a vast potential for profits and losses when investing directly in the futures contract.

Commodity trading through stocks

The indirect way to play in the commodity market is by investing and trading the stocks of companies that produce or deal in the particular commodities you are interested in. For example, if you are interested in agricultural commodities like coffee or rice, you can invest in a company that deals with these products.

Stocks tend to be less volatile and are a bit immune to abrupt price swings. At the same time, they are easiest to exchange, buy and hold. One can easily focus and narrow down the investments to a specific category. But one must do adequate research about companies one is planning to put money in.

The drawback is that stocks are not an unmixed take on the commodity. The price of a commodity stock can also be impacted by factors that include the company’s management or leadership.
One can also invest in options through stocks. Options work similarly as futures contracts. Options necessitate smaller amounts than buying stocks directly.

Commodity trading through ETFs

Investing in commodities through Exchange Traded funds is another way to enter the market. The ETFs work and function just like stocks and allow traders to benefit from the price fluctuations without actually investing in futures or stocks. The commodity ETFs track the price of a clan of commodities by using futures. ETFs allow traders to speculate on the price movements of a group of commodities. There are no or very minimal management charges associated with ETFs. But ETFs are not available for all types of commodities.

Conclusion

Commodity trading can prove to be an excellent way to diversify the portfolio and reduce the risks. Commodity trading is a risky affair because the principles of demand and supply are affected by uncertain events and natural calamities.

But if pursued diligently and correctly, commodity trading can lead to huge profits. If you are eyeing for an online broker to facilitate Bitcoin trading or other trades, we would recommend HFTrading. HFTrading is a regulated broker functioning in New Zealand and Australia. The broker provides trade in a wide range of securities like forex, stocks, indices, commodities, metals, and Cryptocurrencies.

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