Commodities are the raw materials that underpin the entire global economy. From food production to manufacturing, tech to the energy sector, commodities are the building blocks for it all. In this article, we’ll discuss what commodities are, how to trade them, and what decisions you’ll need to make if you’re interested in trading commodities yourself.
What are commodities?
Commodities are, simply put, the raw materials that are harvested, collected and processed into food, goods and the services all human beings use for activities every day.
Trading commodities is different to trading stocks or bonds because they are physical materials and goods. Commodities’ fluctuations in price make them potentially profitable markets to trade in. However, they can also carry more risk than bonds and the stock market, because of unpredictable price movements and the specialised knowledge and research required to stay informed of the market.
How to trade commodities
Before you start trading commodities, you’ll need to choose which commodity you’re interested in. They are typically divided into two categories.
Whether you want to trade energies, learn how to trade oil or trade soft commodities, all of these markets deal with physical goods which must be grown, reared or discovered and then harvested or collected by human labour. This makes them much more vulnerable to a range of outside factors and variable supply and demand than purely financial products (such as stocks and bonds).
Commodities trading is one of the oldest forms of trade and is the original basis for what modern investing has become today. The process might have started with farmers negotiating prices for their goods outside of harvest time, but these days, wanting to trade commodities involves a more sophisticated process. Trading commodities can be done in a few ways, with each offering advantages and disadvantages, which may or may not suit your portfolio and your approach to trading.
One way to conduct commodities trading is through the exchange of different types of assets in the form of futures contracts. Futures contracts allow investors to buy and sell on a futures exchange, with a determined future price for the assets which is agreed to by both parties. Where futures can make traders profits is in the way the actual asset price may differ from this agreed price. The actual price of a commodity could spike or crash due to market forces and external factors — so while a huge fluctuation in price could mean a win for you, it could also expose you to more risk and losses. Commodities futures aren’t involved in the trading of the physical goods and resources themselves — they’re a bet on the movement in price changes only.
Purchasing physical commodities
Unlike futures, which speculate on the predicted price of goods in the future, some types of commodities can be physically acquired by an investor. Because these transactions can cost more than other investments, they are usually only reserved for very value-dense commodities like precious metals and not for assets like crops, livestock or energy commodities.
Commodities stocks offer a way to trade commodities that are linked to a company producing the asset rather than in the value of the raw asset itself. Commodity stocks allow you to obtain indirect exposure to the commodities market, but they do come with some complex underlying principles. For instance, some commodities stocks move in step with the commodity price, while others have a variable relationship with the commodity price and their own stock price.
Here’s an example: a global shortage of a certain commodity like oil might indicate a drop in an oil company’s stock value, but in the longer term, a supply issue would cause increased demand and allow oil to rise in value, thus making the shortage advantageous to oil company stockholders.
If you want to invest in something that closely follows the fluctuation of a commodity’s price, commodities stocks aren’t the best way to do this. If you’re interested in gaining exposure to a commodities market without trading on the asset’s market price though, they’re a great way to do this.
ETF stands for exchange traded funds, and they are a type of investment instrument that works by holding an asset type in a larger commodities basket. Leveraging commodities ETFs is a good way to diversify your portfolio from a single position. However, because commodities ETFs use a process to mimic a commodity’s price, they may not always perfectly reflect the reality of the market.
Ultimately, you need to weigh up the pros and cons of each of these commodity trade options, as well as stay on top of the expert analysis and trade indicators in order to start trading commodities in a way that’s profitable and sustainable in the long term.
Factors that might affect commodity trade
We’ve mentioned expert knowledge, research and analysis a few times here, and it’s worth reiterating that commodities trading really does require keeping a close eye on breaking news and events that will affect the market. But more than just keeping an eye on a particular stock market or a narrow range of investor-relevant updates, commodities trading can be affected by many different global socioeconomic, environmental and political factors. Here are some of them:
Building a strong portfolio with trade commodities
Because commodities trading is by its very nature higher risk and reward than other kinds of trade, it offers some unique opportunities. However, it can also expose vulnerabilities in your portfolio and requires a trader to be able to weather some short-term losses in order to benefit from longer-term gains.
For this reason, many investors choose to dedicate a portion of their overall portfolio to trading in commodities markets. For example, 20% of your total portfolio could be dedicated to commodities trading, protecting you from over-exposure but opening you up to big potential wins down the line.
Ready to create your commodity trading account?
If you’ve been following a commodities market, buffing up on your knowledge of political and environmental factors that might affect it and reading expert insights from financial journalists, you may be eager to open a commodity trading account. At VT Markets, we offer beginner-friendly and globally recognised trading platforms in a user-friendly interface, so you can trade commodities using a transparent and trusted forex trading environment that’s totally secure.
Want to know more about how we’ve designed our systems to meet the needs of clients? Get in touch and we’ll help you with anything you need, from choosing your account type to managing your investment size and leveraging the right commodities trading options to suit you.
How do I start trading commodities?
Once you’ve done your research and decided which commodities you want to trade, VT Markets can help you find the right trading opportunity, monitor your commodities and close in a strong position with the help of powerful official trading platforms MetaTrader 4 and MetaTrader 5.
If you want to start practising the way you trade commodities before launching into global markets, our demo account is a great jump-off point. This zero-cost method is a good beginner option as you become familiar with different trading options, from oil CFDs to soft commodity and energy trading.
What are the most traded commodities in the world?
When it comes to the most traded commodities in the world, the winners, unsurprisingly, tend to be goods that are consumed at a high rate on a daily basis by much of the world’s population.
Hard commodities that are used for energy consistently top the list, with Brent Crude Oil, West Texas Crude Oil and natural gas often leading the list. They’re followed by highly traded metals like steel and copper and consumer goods like coffee and cocoa.