Commodities are the backbone of a country’s economy and include goods that form crucial inputs for several industries. Commodities can be agricultural products or products that are mined or extracted, such as precious metals. They are often traded by producers to ensure regular supply even in turbulent times and by investors to diversify their portfolios. Another reason why commodities trading is popular is that they act as a hedge against inflation. As prices rise, making products expensive, the prices for their raw materials or commodities also increase. Commodity markets are often used as a strategy to offset the loss in purchasing power due to inflation.
There are a number of factors or global events that can have a direct impact of the price of commodities. Price sensitivity to country-related, economic, operational and even climatic factors make commodities highly volatile, thereby offering multiple trading opportunities. Specialised knowledge and awareness of the various factors such as liquidity and interest rates are necessary for those looking to trade commodities.
In this article we will talk about ways to trade commodities, where to trade, when to trade and how to manage the risks involved in commodities trading using investment strategies.
What are the
Steps to Trading
Trading commodities began as a simple way of exchanging goods. It has since evolved and it today comparable with financial markets such as the stock market with commodities able to be traded 24 hours a day, 5 days a week. Investors have several options for trading commodities, each providing its own advantages and disadvantages. The initial step is to decide the appropriate route for your commodities trading followed by the necessary course of action. The available options are:
This option allows traders to enter into futures contracts that are legal agreements to buy or sell a particular commodity at a predetermined price and on a specific date in the future. This method requires the trader to allocate a significant amount of money. Futures trading is done via a futures exchange.
The most popular option to invest in commodities, derivatives offer the advantage of not having to take ownership of the physical commodity. With derivatives, you can simply speculate on the direction of the price movement of a commodity at a specific date in the future. If the price moves according to your prediction, you could earn good returns.
Traders can enter into a derivative contract by paying only a small initial margin to get the right to buy or sell the underlying commodity at a pre-decided price and specific time in the near future. Traders also have the option to settle the contract in cash, instead of taking delivery of the commodity on maturity of the contract.
Trading in commodities futures requires an investor to open an account with an established and reputable broker offering derivatives trading. Traders can then choose instruments like contracts for difference or CFDs, which not only allow them to speculate on the prices of commodities futures but also make the most of leveraged trading.
The oldest way to invest and trade in commodities is to buy them physically and store them for sale later. Rather than speculation on the price of gold, this option involves the physical purchase of commodities such as gold bullion. One would then have to factor in the expense of storing the commodities and ensuring their safety. Physical purchase can be done directly between the two parties or via established exchanges.
Another way to gain exposure to commodities is to invest in the stocks of companies involved in the production of a commodity. You can buy stocks of oil refining or drilling companies, those that sell seeds or mine gold. Since the stock prices of these companies follow the price of the underlying commodity, it allows traders to reap the benefits of stock as well as commodities trading. Here too, you will first need to open an account with a trusted broker to start trading.
Commodity ETFs (Exchange-Traded Funds), Mutual Funds and Exchange Traded Notes
This option involves investing in funds that invest in a large portfolio of stocks of different companies that offer commodities exposure or buy futures contracts to track the price of a commodity. Again, trading is done via brokers.
Commodity Pools and Managed Futures
With this option, several investors get together to combine their funds to invest in commodities. These funds work like mutual funds but are not publicly traded. This method may prove to be costly.
Once you have finalised the route through which you wish to trade commodities, the next step is to choose a broker to open a trading account with. Opening an account is simple, with easy Know Your Customer (KYC) processes. Once your account is activated, you will need to deposit the specified margin amount to begin trading on the live markets.
What are the
Best Strategies for
Beginners to Trade
The significant volatility in commodities prices ensures that traders get multiple trading opportunities. However, to be successful at trading commodities, it is vital to adopt effective trading strategies that have been tested before or are based on extensive research. Successful traders research commodity markets extensively, while also gaining knowledge of the factors that affect the commodity they wish to trade. They then establish strategies, using a demo account to first test their efficacy before applying them to the live markets.
Trading strategies are usually based on fundamental or technical analysis, or a combination of the two. Fundamental analysis involves being up-to-date with various events or economic announcements that can impact commodity prices. This is possible by staying abreast of the latest news and using an economic calendar to follow the release of important economic data that could impact prices.
Established brokers offer extensive resources and tools, including the economic calendar, that provide traders with the latest information. In a high-risk market, it is essential to make informed decisions with respect to your investment portfolio.
Using a good trading platform is highly useful for traders looking to base their trading decisions on technical indicators. Established platforms like MetaTrader 4 (MT4) are equipped with inbuilt tools that make technical analysis easy and fast, thereby allowing traders to make informed decisions. They provide real-time pricing making it east to track price movements, moving averages and trend lines.
4. Trading Breakouts
This trading strategy is used to capitalise on the short term movements in commodity prices and involves a trader buying just before substantially higher prices or selling just before the price declines significantly. The key to this strategy is successfully identifying a breakout. This strategy is quite effective when a trend is strong and expected to last for a long time but is not recommended for short-term trends.
5. News-based or Fundamental Trading
This strategy can be based on both fundamental and technical indicators. Trading decisions are based on weather forecasts and their impact on production levels of a commodity or other announcements that could lead to increased demand. Traders need to spend some time researching and analysing the impact of an event or announcement prior to executing trades. Awareness of the commodity’s origin, its consumer base and future demand are crucial for this trading strategy.
This strategy aims at capitalising on minor fluctuations in prices. As a result, traders need to be highly alert at all times to identify trading opportunities. In this strategy, the trader enters into several trades in a single day, exiting each position after very short durations. The aim is to earn small profits with each trade. Small duration charts are highly useful for this strategy.
A brokerage account with low trading costs is essential with this strategy due to the amount of trades placed. It is also important to remember that no trading strategy can guarantee success. It is useful to regularly review your strategy or even combine two or more strategies to make a trading decision.
What is the Best
Platform for Trading
Choosing the right platform can ensure that you are able to place your trades quickly, gain access to robust analysis, and have a seamless trading experience. This requires careful consideration of the various platforms available for commodities trading before choosing the right one.
While MT4 remains the most popular online trading platform, MT5 is closing the gap, especially among experienced traders. The ability to trade in a larger number of instruments and asset classes from a single account are part of this. The opportunity to use advanced strategies and utilise a greater number of analytical tools are beneficial for those conducting fundamental and technical analysis.
Some of the most attractive features of MT4 that make it the most popular platform are:
User-Friendly: The platform is offered for free by established brokers. It is simple to understand and easy to navigate. It provides users with all the information they need to trade an asset under one roof. It is suitable for all types of traders, regardless of whether you rely on fundamental or technical analysis.
Compatibility: The platform is compatible with Windows, Android and iOS devices, which means that you can access trading even on the go.
Technical Indicators: MT4 comes with in-built technical indicators that allow users to carry out technical analysis to chalk out a strategy and take positions.
Market Watch: This feature of MT4 offers users insight into the market and the latest trends.
Expert Advisors: These specially written programs allow users to automate trading, based on pre-decided parameters. The EAs can be customised according to an individual trader’s needs and preferences.
Big User Base: The large user base on this platform ensures that traders get access to many free indicators online that can be incorporated in their trading strategy. It also means that you can find quick solutions online to any problems you may face in using the platform.
Account History: The platform provides easy access to all information related to a trading account. This includes all the trades that have been made, with details about the profits and losses too.
Alerts: The Alerts section on MT4 is very useful for staying updated and making informed decisions.
One-Click Trading: It allows one-click trading from the charts themselves, which makes it highly useful for scalping.
Multiple Languages: It supports multiple languages, allowing traders from different parts of the world to use it effortlessly. In recent years an increase in demand from smaller countries has seen additional languages added.
Option to Back-Test: It has a unique back-testing functionality that allows traders to test new strategies before applying them in the live markets.
Traders looking to trade commodities by taking advantage of the price volatility tend to favour commodities futures. A basic requirement for trading futures is having adequate funds to buy futures contracts on a big exchange, making it unaffordable for many investors. The problem was resolved with the introduction of commodity CFDs or Contracts for Difference. CFDs allow traders to speculate on commodity prices with only a fraction of the total amount needed to open a position. They are fast emerging as a popular option to trade commodities due to the several advantages they offer.
CFD brokers offer traders a chance to trade in commodities by entering into trades at prices based on futures contracts. Some brokers also offer CFDs based on spot or market prices, allowing traders to choose according to their trading style.
CFDs do not involve taking actual possession of the underlying commodity and instead allow you to speculate on the price movements in the future.
CFD trading is leveraged, which means that a trader can gain much higher exposure than the funds available in their trading account. The trader only has to deposit a small percentage of the overall value of a trade (the margin money), while taking on the entire profit or loss.
The margin requirement is low in the case of CFDs, as compared to the futures markets, because the latter involves trading in standard lot sizes, which may be out of the reach of small traders. In contrast, CFDs can be traded in smaller lots, allowing better risk management.
CFDs allow a trader to take both long or buy and short or sell positions, taking advantage of both the rise and decline in the price of the underlying commodity.
CFD brokers generally do not charge any commissions and instead earn only from the spread, the difference between the bid (selling) price and ask (buying) price.
The market for the most liquid and highly traded commodities, like oil and natural gas, are open 24 hours on weekdays, which means that CFD trading can be conducted 24 hours a day, 5 days a week.
Trading in most of the liquid commodities via CFDs is offered by reputable brokers on attractive terms.
Trading commodities via CFDs is a convenient method that requires lower investment than others. Choose the commodity that you wish to trade and find a reputable broker that offers CFD trading in it. Follow this up by opening a trading account and depositing the margin money. It is always useful to first work on a demo account to acclimatise yourself with the trading techniques and other nuances of trading CFDs, before investing any real money.
What are the Top
Tips for Trading
Commodities trading courtesy of high levels of volatility that create a substantial amount of trading opportunities. Commodity prices depend not only on the demand and supply situation but the overall economic scenario, the political situation, the climate, natural disasters, policy issues and many other factors.
Also, each commodity has a unique profile that needs to be considered while trading. It is essential to have a well-planned strategy that includes risk management measures. Here are some other useful tips for trading commodities:
Commodities trading is not similar to stock trading and requires in-depth knowledge of the various factors that can affect prices. This includes careful consideration of political ties between different nations involved in the production and consumption of a commodity or the impact of a natural disaster or economic fundamentals of a region.
Portfolio diversification is useful with many traders using commodities to hedge risk.
Do not use a blanket approach for trading all commodities. Instead, identify the factors that influence each commodity and keep track of their impact on prices. Check the timeframes for trading various commodities and the general trends.
Identify the correlations between different commodities and the impact of a change in price of one on the other. The correlation between a commodity and currencies is also useful. For example, an increase in the value of the US dollar tends to have a negative impact on gold prices. Identifying such correlations can help you make informed decisions.
Different commodities have different volatility levels, so try taking larger positions in commodities that are less volatile and smaller positions in commodities that are highly volatile.
Ensure that you base your lot size on the volatility level and not the extent of margin.
Identify the trends. Commodity prices change with the seasons and the consequent demand. Take note of this and plan your trades accordingly.
Use leverage carefully. Excessive use of leverage can result in magnified losses, which could even wipe out your entire trading account. So, it is best to use leverage based on the amount you can afford to lose.
When trading commodities, it is paramount to choose a regulated broker to open your trading account with. Regulated brokers not only adhere to all the applicable rules and regulations, but also keep client funds separate from their own operating funds. Other things to look at while choosing a broker for commodities trading is the trading platform offered, the assets available, the spread, the leverage and margin requirements, the resources being offered and the payment terms.