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What is Commodity Trading?

Commodities trading is perceived as a domain of seasoned experts. It is a financial approach that provides substantial opportunities for diversifying one’s investment portfolio and profits. They are present everywhere, right from the food we consume to the energy that powers our homes.

Understanding how to navigate commodities will offer a deeper appreciation of the world around us. Here, we will explain about commodity trading, from its fundamental principles to the practical steps on how you can start investment in commodities.

Understanding the Type of Commodities

Commodities are the lifeblood of the global economy. They are the goods, typically the raw materials or primary agricultural products, that are standardized and interchangeable with other goods of the same type. These commodities can be traded (bought and sold) in the market easily.

Commodities are divided into two major categories:

  1. Hard Commodities: These are the types of commodities that are extracted or mined. They include metals like gold, silver, copper, etc. Examples of energy resources are crude oil and natural gas.
  2. Soft Commodities: Primarily, this commodity type consists of agricultural products, including crops like wheat, corn, coffee, livestock, etc.

Let us focus on some of the popular energy commodities.

Crude Oil: The Basics

Crude oil is also referred to as “black gold” in the commodity market because of its essential role in the energy sector. It is an unrefined petroleum extracted in its natural form from the earth.

To track its prices in commodity markets, West Texas Intermediate (WTI) and Brent Crude are used.

Factors Affecting the Price of Crude Oil (including but not limited to)

Here are some significant factors that affect the price of crude oil:

  • Supply and demand: The law of supply and demand plays a critical role in the price movements of crude oil. Prices can fluctuate easily if there is any disruption in the global supply or increased demand.
  • Geopolitical events: Situations like wars, sanctions, or political instability in the regions where oil is produced can create supply disruptions and send shockwaves through the market. This can also be a deciding factor in commodities prices.
  • Economic Indicators: GDP growth, inflation, and employment rates can significantly influence the global demand for oil.
  • Currency Movements: Oil is priced in US Dollars; thus, any fluctuations in the exchange rates of the currency will directly impact on the price of commodities.

Brent Oil: The Basics

Brent oil is another significant commodity, extracted from the North Sea, and is one of the major components in the global energy market. It is repeatedly compared with West Texas Intermediate (WTI) crude oil, which is extracted from the United States.

Key Differences Between Brent and WTI
Basics Brent Oil WTI
Geographic Origin Sourced from North Sea. Sourced from the United States.
Composition Lighter, sweeter with low sulphur content Higher sulphur content, making it difficult to refine.
Pricing Influences International oil markets Affects the US market

Natural Gas: The Basics

Another type of commodity that commodities traders usually trade in is Natural Gas. It is a versatile energy source often used for heating, electricity generation, and as fuel for vehicles. It is found underground in gas reservoirs and is primarily composed of methane.

Factors Affecting the Price of Natural Gas
  • Weather Patterns: Extreme weather conditions can significantly affect the demand for natural gas, making it a deciding factor in the prices of commodities.
  • Storage Levels: Higher reserves can lead to oversupply and lower prices and vice versa.
  • Geopolitical Factors: Supply disruptions caused by political events can impact natural gas prices. Hence, you need to strategize your commodity trading accordingly.

The Role of Commodities in the Global Economy

Commodities are the building blocks of our modern world and are fundamental to industry, agriculture, and construction. Consequently, their supply and demand dynamics are highly influenced by a myriad of factors, including global economic conditions, geopolitical events, and weather patterns. Let us have a look at the commodities market.

Exploring the Commodities Market

Majorly the commodities market is divided into two segments, namely, spot and futures markets.

Spot Market involves the exchange of physical commodities immediately. On the other hand, futures markets revolve around the contracts that stipulate the delivery of the commodity at a said date in the future.

Major Commodity Exchanges

  1. CME or Chicago Mercantile Exchange: It is one of the most extensive futures and options exchanges globally. It offers a wide range of commodities, inclusive of agricultural products, energy, and metals.
  2. ICE or Intercontinental Exchange: It is known for the energy futures and options. Besides this, it also offers contracts on agricultural products and soft commodities.
  3. LME or London Metal Exchange: It specializes in non-ferrous metals, including copper, aluminum, zinc, etc.

Who are the Participants of the Market?

There are usually three types of commodities traders in the market, including the producers, consumers, and speculators.

  1. Producers: They are individuals or companies involved in the extraction or production of the commodities. They often use the commodities market to hedge against price fluctuations and stabilize their income.
  2. Consumers: Next comes the end-users of the commodities, including the manufacturers. They use the market to secure a stable price for their raw materials and production costs.
  3. Speculators: They are the commodities traders who buy and sell commodities for the sake of profit only and take advantage of the price volatility.

Challenges Associated with the Commodities Market

  1. Price Volatility: Volatility can be a mixed blessing as the same price volatility that offers opportunities in Commodities trading also poses a risk. Prices can rapidly change because of numerous factors, including the imbalance between supply and demand, geopolitical events, and natural calamities.
  2. Geopolitical Risks and Regulatory: Commodity market trading is subjected to a complex web of regulations that changes over time. In addition to that, geopolitical events like trade disputes, sanctions, and political instability can directly impact the prices of the commodities.
  3. Lack of Physical Ownership: Commodities trading does not involve any physical ownership of the underlying asset like stocks or real estate. A sound understanding of the market and trading procedures is required because commodities traders deal in contracts, which can be tedious.

Benefits of Commodities Trading*

There are several benefits associated with commodities trading.

  1. Diversification of Investment Portfolio: It is an effective way to diversify your investment portfolio by incorporating commodities as they have a low correlation with traditional assets like stocks and bonds. They can help reduce the overall risk in your portfolio.
  2. Hedge Against Inflation and Currency Fluctuations: Historically, commodities like gold acted as a hedge against inflation. When the value of the fiat currency falls due to inflation, the price of commodities rises.
    Fiat currency: It is the national currency that is pegged to the price of a commodity like gold or silver.
  3. Potentially profitable in the volatile market: Commodity markets are known for their price volatility, which can act as an opportunity for profit. Traders who can analyze and anticipate these price movements can benefit from the market’s fluctuations.

*Always depending on the investment objectives of each trader

How to Start Commodities Trading?

  1. Research: Before delving into the commodities market directly, it is advisable to invest time in educating yourself about the market. This includes understanding the fundamental drivers as well as staying up to date with the news and events that can influence the prices. This is one of the most essential steps when you are learning to trade in the commodity market.
  2. Selecting a commodity: Before delving into the commodities market directly, it is advisable to invest time in educating yourself about the market. This includes understanding the fundamental drivers as well as staying up to date with the news and events that can influence the prices. This is one of the most essential steps when you are learning to trade in the commodity market.
  3. Choosing a trading method: Commodities trading can be executed using various methods, including:
    • Future contracts: They are standardized contracts that oblige the buyer to purchase and the seller to sell a specific quantity of a commodity at a predetermined price and date.
    • Options: They are standardized contracts that oblige the buyer to purchase and the seller to sell a specific quantity of a commodity at a predetermined price and date.
    • Physical commodity trading: This involves buying and taking delivery of the commodity. However, it is less common amongst traders and requires significant capital.
  4. Open a trading account: To begin commodities trading, one will need to open a trading account with a brokerage that offers access to the commodities market. You can start commodity trading with Exclusive Markets by opening a Demo or Live account. It will allow you to generate high returns on prominent commodities and is well-regulated to protect your interests.
  5. Risk management: Establish a risk management parameter before embarking on your commodities journey. Determine the amount of capital you are willing to risk and set the stop-loss orders to limit potential losses.
  6. Developing a trading strategy: A combination of technical and fundamental analysis is required to have a successful commodity trading strategy. It should consist of a trading plan and the discipline to stick to it.
  7. Initial capital and margin requirements: Consider the amount you are willing to invest in commodities trading. Also, comprehend the margin requirements set by your brokerage because this will significantly affect your trading capital.

Some Commodities Trading Tips for Success

  • Stay updated with the market news: Have a keen eye on the ongoing news and events, as they impact the commodity's price. Also, stay informed about the factors that can influence the market.
  • Religiously Practice Risk Management: By setting the stop-loss orders and avoiding over-leveraging.
  • Continuous Learning and Development: Stay up to date with the industry trends and market developments as commodities trading is a constant process.
  • Build a network of Experienced Commodities Traders: Networking with other traders can provide valuable insights and support.

Conclusion

Commodities trading is a dynamic and potentially profitable financial venture. With the proper knowledge, strategies, and risk management, one can effectively navigate the commodities market. While it may seem complex at first, starting with thorough research can set you on a path to becoming a successful commodities trader.

With competitive spreads and advanced tools, Exclusive Markets offers you the chance to diversify your investment portfolio by trading commodities.

Remember that risk is inherent in trading, and it is essential to approach commodities trading with utmost caution and discipline.

Are you Ready to Explore the World of Trading?

Disclaimer: The information provided on this blog is for educational/informational purposes only and should not be considered financial/investment advice. Trading carries a high level of risk, and you should only trade with capital you can afford to lose. Past performance is not indicative of future results. We do not guarantee the accuracy or completeness of the information presented, and we disclaim all liability for any losses incurred from reliance on this content.