Commodity Trading: The High Risks of Commodities
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What Is Commodity Trading?
Commodity trading revolves around markets that translate to the very building blocks of our societies. Commodity trading describes the buying and selling of fundamental, raw materials like oil or corn, or precious metals like gold and silver. Commodities are often grouped into two subsections: hard and soft. Hard commodities include oil, natural gas and precious metals; soft include cocoa, coffee and soybeans.
Commodity markets are some of the oldest and strongest in the modern world, bolstered by consistent global demand and ongoing volatility. Commodity traders will typically buy and sell through futures contracts, betting long or short, depending on price action analysis. However, with FP Markets, CFDs (Contract for Differences) are another derivative vehicle traders can adopt to engage in the commodity market.
Which Is the Best Commodity for Trading?
There is no set ‘best’ commodity. Different traders have different strategies, and each commodity ranges in risk, liquidity and volatility, meaning that the ‘best’ commodity will depend entirely on the trader. It is clear, however, that when looking solely at historical performance, some commodities outperform others, offering more impressive returns over the long run. Before trading any commodity, it’s crucial to understand the underlying weight behind supply and demand trends and how these affect market prices and current trends. Supply and demand can be influenced by anything from geopolitical tension to extreme weather. So, traders need to stay ahead of the curve to understand the reason behind the price of a commodity.
Looking at performance over the last year, natural gas stands as the leading commodity, with an annual increase of 183%. As mentioned, the fluctuations in commodity pricing depend on the health of the global market. The sanctions involved in Russia’s invasion of Ukraine disrupted the stability of the natural gas and oil markets, with both markets under tightening scrutiny with key supplier Russia out of the question for the time being.
Can You Make Money Trading Commodities?
Commodity trading can be incredibly lucrative if done correctly. Investors can buy and sell commodities physically or through futures contracts, the latter being the most popular and profitable method. The use of futures contracts means one thing, access to leverage. Leverage means traders can open positions with only a fraction of the required capital (margin). Alluring through the idea of supersizing profits with leverage, traders need to be aware of the landslide losses that are also possible through poor risk management and over-leveraged positions.
In short, a trader that is particularly clued up on global events, risk, and supply and demand has a good chance of understanding the commodity markets and hence is likely to turn a profit.
High Risks of Commodity Trading
Trading commodities is all about speculation. Unlike the strength of a particular currency pair or company stock, movements in commodity markets revolve around the faith of buyers and sellers regarding global supply and demand. There are inherent repetitions in how markets move. Still, generally, traders buy into commodity markets on a speculative theory that over time, the price of the given asset will increase - normally tied to increasing global demand.
The other high risk when it comes to trading commodities is unbridled volatility. In times of peace, global security and strong economic welfare, commodities should trade with some degree of stability. However, geopolitical tensions or tricky global affairs can easily result in a simple shift in demand-supply dynamics. An upset of the usual global dynamics can result in a huge price shift, meaning that whilst commodities offer lucrative upside, the downside risk is equally as strong. Prices for commodities can shift more than a currency pair or a stock value, hence the dramatic losses.
High Rewards of Commodity Trading
On the other side of the coin, the commodities market can be very rewarding for educated, professional traders. The opportunity to hedge against sharp fluctuations and protect a trading account against bouts of inflation can be appealing. Commodity markets typically thrive as investors look for safer avenues with more stable price movements. By trading commodity futures or CFD contracts instead of physically purchasing the asset, traders can also benefit from a much lower initial margin.