Commodities - from oil and gas to agricultural produce - are bought and sold on exchanges via contracts and financial instruments.
The sale and purchase of commodities are usually carried out through futures contracts, and there are two types of traders that trade commodity futures.
The first are buyers and producers of commodities that use commodity futures contracts for hedging against future price movements. These traders will make or take delivery of the actual commodity when the futures contract expires.
For example, a cereal farmer who plants a crop can hedge against the risk of losing money if the price of his crop falls before it is harvested. The farmer can sell wheat futures contracts when the crop is planted to guarantee a predetermined price for his wheat at the time it is harvested, even if the market price has fallen, for example because of a bumper harvest and a resulting glut.
Traders may aim to buy when the price is low, which is usually determined by an abundance of supply and falling demand. They sell when they believe the supply is outweighed by the demand, which can result in a profit.
The second group who may trade in commodities futures are speculators. The prices on commodities markets are very volatile. These are traders who trade in the commodities markets for the sole purpose of profiting from this volatility. These traders may never intend to make or take delivery of the actual commodity when the futures contract expires.
Many of the futures markets have a high degree of daily range and volatility, making them attractive for intraday traders, as well as brokerages and investment managers to offset risk and for diversification – many commodities tend not to trade in tandem with equity and bond markets.
What moves a commodity's price?
To be successful, commodity traders need to predict the direction that markets will take. This can require fundamental and technical analysis, and an understanding of the key factors which will influence the market movements of a particular commodity.
Commodities prices are driven by the forces of supply and demand, and very large price swings can occur when scarcity or abundance of a commodity suddenly looks likely. These can be triggered by regular events, such as seasonal demand for energy, or less predictable factors, such as a bad harvest affecting particular crops. They may also be affected either positively or negatively by developments in a particular industrial sector, a national or regional economy, or even global events.
With commodities futures, if a trader believes that a commodity such as oil will rise, they can place a buy trade, and if they believe that it will fall, they can place a sell contract.
With a buy, if the market price rises, they could make a profit for every point of that rise. If the market falls, they will make a loss for every point the index moves against them.
With a sell, profit can increase as the index falls.
Leverage in commodity CFDs
CFDs are a leveraged product. This means that you are only required to deposit a small amount of money to place a trade and gain a larger exposure to the market.
However, the higher the stake, the more money you need as a deposit (known as margin) to place that trade. It is important therefore that you make sure you have enough funds to cover the trade.
You should also remember that a leverage will work against you if the market moves against your position.
You can use stop and limit orders to help ensure that you lock in your profits and minimize your risk when your profit targets and risk limits are reached.
Like options and futures, CFDs (Contracts for Difference) are another derivative that can be used to speculate on commodities.
A CFD is a contract between a trader and a broker. CFD traders may bet on the price moving up or downward. Traders who expect an upward movement in price will buy the CFD, while those who see the opposite downward movement will sell an opening position.
Getting started in Commodities trading
To get started with commodity CFDs, open a demo account to access our trading platform. You can take all the steps to start trading on price movements of commodities, such as choosing from a variety of instruments, buying or selling via order tickets, and implementing risk management techniques.
You can open a demo account here.