Commodities are exchanged throughout the world, with a variety of financial instruments that allow access to this market. Trading in commodities is a great way to diversify an investor’s portfolio and is one of the oldest forms of trading and investment.
The commodities market is seen as quite a safe haven, in particular, the trading of gold, as the trends tend to move in opposite directions to the stocks market. Investors can therefore rely on commodities when there are periods of volatility in other markets. Here we explain exactly what a commodity is, the varying options of commodities and the different ways to trade in them.
What is a commodity?
Trading commodities has taken place since ancient times, and is an older form of trading compared to stocks and bonds. The strength of an empire in history can be traced back to its ability to trade in commodities and the systems created in order to do so. But what are commodities?
A commodity is a physical good that can be traded (meaning it can be bought or sold) and on the commodity market, is categorised into two varieties:
- Hard Commodities are those that are natural resources that are often mined or extracted, such as oil or gold
- Soft Commodities are farming goods that are grown or produced, for example coffee or wheat
From this, the commodities can then be sub-categorised into four types:
- Livestock and meat
Crude oil is probably the most common of these to be traded, and is widely invested in around the world. It falls into the ‘hard’ and ‘energy’ categories presented here, and can be traded via futures contracts or CFD trading.
The quality of each commodity is always uniform, as there are set specific requirements that have to be met in order for the commodity to be traded on an exchange. However, the value of that commodity depends on several factors such as politics or the economy of a nation, weather conditions and natural disasters, many of which are uncontrollable. The trading in commodities and their values, in its basic form, is based on supply and demand.
Commodities and Traders
Commodity traders will buy and sell a range of the different types of commodity products, from oil to gas, gold and silver to wheat and corn, taking advantage of both soft and hard types. Trading in this market takes a lot of analysis of price charts, market movements and predicted forecasts of market trends. The utilisation of this analytical data is to benefit from estimated future price movements and the likelihood of an abundance in the supply of the commodity or a fall in demand, with the aim to buy when the price is low and to sell when there is a result of profit.
Major events are key to the analysis of the commodity market, and have a huge impact on its movement, although some cannot be anticipated at all. These include political disruptions or economic uncertainty, unusual weather patterns, widespread pandemics, and natural disasters that can impact the physical production of the goods. When it comes to gold, the typical market price is based in dollars, therefore the relationship between the US dollar and gold is a key influence. The rise and fall of the dollar can hugely affect the price of gold.
Commodities can therefore be a risky investment, as the market is impacted by uncontrollable factors or uncertainties that cannot be predicted. Traders most commonly use future contracts if in a business using the physical good, or Contract for Differences (CFDs) as a commodity speculator, which means that they do not physically own the goods, but take a long or short financial position.
Ways to invest in commodities
There are several ways to invest in commodities, including futures contracts and CFDs, as previously mentioned. In an exchange using a future contract, the prices are effectively agreed upon in advance, with a standardised quantity and set date, and the aim to minimise volatility this way. This direct form is usually used by commercial or institutional users of the commodities, to ensure that the trade is part of their budget plan and to reduce the risk of financial loss if there is a change in price.
With CFD trading, the underlying commodity is not owned, therefore is common amongst speculative investors. It allows them to speculate on the price movements of different commodities, which is beneficial in a sometimes volatile market. CFDs also allow for more exposure to the market with leverage trading, maximising the profits with a smaller initial investment compared to traditional trading. Thus, this form of trading provides opportunities to both novice and experienced traders.