How commodity trading works

How commodity trading works

There is a similarity with all traders participating in the investment industry. Whether you are trading CFDs, ETFs or currency we all have one objective, to make money. Commodity trading nowadays is done via CFDs. CFD trading is extremely popular in today’s world since people can easily use the market leverage and buy and trade assets. In the past, commodity trading had to be done in a physical marketplace, but things have changed a lot with the recent advancement in technology. The retail traders can easily access the CFD market just from their home. They can even analyze the historical data in their trading platform and make a decent profit by day trading the market.

Traders usually use the commodity market to trade a future contract. The process involves a mutual agreement between the buyers and sellers. Sounds a little bit confusing? Don’t worry we will make things pretty clear. Let’s say a farmer wants to sell wheat in the future at a certain price. If the sellers agree upon the contract of the farmer, the farmer will have a future contract of the wheat based on delivery of the future date. To be precise, you are just buying an underlying asset based on mutual agreement of the future price.

Commodity trading has been around for ages now, but still, it has not lost its momentum. Without it, the world would almost come to a stand still. Our ancestors used to trade the commodity market in exchange for a certain product at a future delivery time. Technology has made this much easier as you can trade the CFD market from the comfort of your home. There are four major types of commodities that are most popular among traders. These are

  1. Precious metal

  2. Energy resource

  3. Livestock and meat

  4. Agricultural products

Precious metals are extremely popular among the professional online commodity traders. If you can predict the price of a certain asset accurately, you can easily make a decent profit without actually buying the underlying asset. The mutual agreement between you and your broker is enough to secure your future profit. Those who are completely new to the trading industry might think this is a very complex process. But in reality, this process is extremely simplified and automated. Let’s say you want to buy gold since you are expecting the price will rise higher in the near future. So do you need to buy the gold physically? The simple answer is NO. The broker will open a contract for you at the desired price and if the value of the gold rises you will be able to make a profit. All these complex processes are done through the online trading platform. All you need to do is analyze the gold chart and place the trade.

Types of investors

There are two major types of investors in the commodity market. The commercial investors are the big players, and they analyze tons of data to make a prediction on the price, they ultimately invest and tend to make a profit out of it. On the other hand, the speculators are the retail traders and they never actually buy the underlying asset in the real market. They simply speculate the price with a hope that its value will rise higher over the period of time. Being speculators you need to remember, prediction of the future price is all about dealing with probability. So there is no guarantee you will be making money, however, if you master the art of trade management, chances are high you will become a profitable trader. See the review of best online brokers to support your trading approach.

The key advantage of trading commodities

  1. A safe haven in times of crisis: Sometimes investors may not be very confident about trading in commodities. However, think about this, precious metal like gold and platinum can be a good store of value during inflation or times of economic uncertainty. They don’t easily lose value and are easy to liquidate.
  2. Hedging: Whenever the dollar or the euro loses value, then you will need more money to purchase commodities. As more investors sell off alternative investment options to buy commodities, the price goes up. So if you have commodities in your portfolio during crises, you can easily hedge against risk.
  3. High returns: Trading in commodities is a risky venture, but with high risk come high returns – if you can plan and execute your trades well.

The disadvantage of commodity trading

  1. High-risk exposure:

    Everything seems perfect with the commodity trading industry. But when things are too good, you need to understand the risk is also high. Since you will be placing trades with big lots by taking advantage of the leverage, there is a high chance of losing a big sum of money.

  2. Very high volatility:

    The price movements in the commodity market are extremely volatile as compared with the stock market. A streak of losing trades can leave your account in bad shape.

Preparing yourself as a commodity trader is a very challenging task. As a new trader, you need to trade the market with proper risk and trade with discipline. Regardless of the quality of the trade setups, you need to focus on proper risk management. Since the market volatility is extremely high, you should never risk more than 3% of your account balance. Try to limit your risk exposure in every possible way. And always try to find trades with high risk-reward ratio so that a few wins can cover many small losses (being disciplined and setting stop-losses is key). Since the financial market is totally unpredictable, you need to prepare yourself to embrace consecutive losing trades. No matter how good the trade setups are, you should never risk a significant portion of your investment in any given trade. This is a business just like any other, and you need to follow the basic rules of investment.

 

There are a number of articles that expand on commodities trading through to selecting the best CFD broker. These include:-

Commodities the basics

ETF Vs CFD explained

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