Your guide to trading the commodities markets
Commodities, for the most part, are raw goods or materials and are traded internationally as they are used in the production of other consumer goods. For example, gold is used mostly for jewelry and palladium by the automotive industry. There are too many commodities too list but if you want to trade a specific commodity in the financial markets, you need to check that your broker provides it in its offering.
The most popular tradable commodities are:
- Precious metals: gold, silver, platinum and palladium
- Agriculture: corn, wheat, coffee and sugar
- Energy: natural gas, Brent and Crude oil
The importance of commodities
As you can imagine, commodities are the building blocks of the global economy. A shortage in a particular commodity’s supply chain can have adverse effects for entire industries which in turn may affect a country’s economy. A shortage or surplus in a commodity will have an impact on supply and demand and therefore the going price of the commodity on the market. As such, commodity traders and investors need to pay attention at the inventory records announced by companies in the respective sectors if they wish to stay ahead of any surprise changes in rates.
Some commodities are prime investment assets due to the fact that they can serve as a means to diversify investment portfolios that are mainly focused on stocks and currencies. Since commodities tend to move in the opposite direction of these markets, they offer great hedging opportunities in times of crisis in the stock market for example.
The reason why this happens is simple. Let’s say the price of palladium – a metal used heavily by the automotive industry in the production of petrol engines – increases by a large margin because of a strike by the miners; this translates to a cost increase that Nissan or Honda may need to absorb in order to make their cars. This will later affect revenues and therefore the performance of their respective stocks.
Common pitfalls in trading commodities
As already mentioned, commodities tend to be quite volatile which may provide bigger price movements for more profitable trading, but this also comes with the equivalent exposure to risk.
Trading a commodity that is vulnerable to geopolitical tensions like oil can prove to be quite risky in this regard. Especially since oil is the world’s most valuable commodity, there is high competition between the biggest oil exporters like Saudi Arabia, the U.S, Iraq and Russia. This leads to trade wars, sanctions and other events that can negatively affect the market sentiment.
Therefore, you should always ensure that you are employing proper risk management strategies to protect your investment in case of an event that can negatively affect the underlying asset you are trading. If you aim to invest in commodities, it would also behoove you to diversify your portfolio across multiple industries or regions in order to secure part of your funds in case a whole sector starts declining rapidly.
A useful metric for the performance of several commodity markets is the U.S dollar or the DXY index which tracks how the dollar stacks up to the economies of other developed countries. The value of the dollar is incredibly important in commodity trading because to facilitate global trade, almost every commodity is priced in dollars. As such, a weak dollar means increased purchasing power for foreign countries while a strong dollar lowers the demand for expensive commodities in times of economic uncertainty.
The best approach to investing in commodities
While there are multiple ways to access commodity opportunities through the financial markets e.g. buying the actual commodity itself in case you are interested in precious metals – the most accessible way to trade is by trading commodity CFDs with a forex broker.
CFDs (contracts for difference) allow you to speculate on the difference between the current going rate and the price the asset reached when you closed the trade. So, you can speculate the price of gold will go up and if it does, you make a profit. Similarly, you can also speculate that the price of oil will decline, for example, and still realize a profit if you are correct in your assessment.
Therefore, CFDs can provide you with exposure into a diverse range of financial markets from one trading platform, without owning the underlying asset and you can also speculate and profit in both trending and falling markets.