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Guide to Commodity Trading

Guide to Commodity Trading

2022-12-22 • Updated

Information is not investment advice

What are commodities?

A commodity is an essential good or raw material people use to meet their vital needs and produce more complex goods. In other words, commodities are the building blocks of the global economy as they are used to create products people rely on in their everyday lives. The most commonly used commodities are oil, gas, wheat, corn, cotton, gold, silver, copper, aluminum, coffee.

What separates commodities from other goods is that they are mostly standardized. It means that two equivalent units of the same commodity will be identical, no matter where they are produced. 

Why is commodity trading so popular?

Commodity trading has several advantages compared to trading stock, crypto, or Forex markets. 

Great for Short-Term Trading

Commodities are highly volatile. This is an advantage for traders because there are plenty of everyday trading opportunities. It is possible to trade commodities in both directions, earning on both asset growth and downward price movement. Therefore, this type of asset is the most popular among scalpers and day traders. 

Hedge Against the Stock Markets

Another reason why you might decide to trade commodities is the possibility of trading them as a part of a hedging strategy against the traditional stock markets. Commodities are fundamental for the global economy. Therefore, the changes in their prices are significant in times of growing tension. In times of crisis, when investors turn away from risk-on assets such as stocks and crypto, commodities gain the highest volatility.

For example, when stock markets are down because of economic or geopolitical fears, traders and investors turn their eyes to the gold market, hedging against the stock market's downfall.

On the other hand, when the stock markets are about to recover, gold will suffer, as capital will move into equities. That's why gold was one of the best-performing asset classes during the 2008 financial crisis.

More Suited for Fundamental Analysis

When attempting to profit from short-term price fluctuations, much of the focus goes to technical analysis. You will require great skills in technical chart analysis, which can take a significant amount of time to master.

However, the prices of commodities like gold, oil, and natural gas are often dictated by external factors that are much easier to evaluate.

For example, increased tensions in Ukraine at the end of February 2022 forced traders to turn to the metals market as they wanted to hedge against a possible collapse in stocks and cryptocurrencies. As a result, XAUUSD (gold) gained 8% within one week due to increased demand, which pushed the prices up.

XAUUSD gained 8 percent.png

So, even if you are only just learn to trade commodities online, you can give yourself the best chance of predicting some market trends simply by following the international news. 

Leverage can boost gains

When trading commodities, you can use "leverage" to gain control over a larger amount of money with just a small deposit. It i's an advantage because it can potentially increase your gains. On the other hand, leverage can also magnify your losses, so it's important to use proper risk management and Stop Loss orders to limit the odds of losing money. 

Types of commodities

Commodities are often classified as either "hard" or "soft." Hard commodities are generally natural resources mined or extracted from the ground. Examples include gold, copper, and oil. Soft commodities are agricultural products or livestock grown or raised on a farm. Examples include sugar, cotton, and wheat.

However, traders usually divide commodities into three main categories: metals, energies, and agriculture. Let's take a look at each of these categories.

Metals

Metal commodities are commonly used in manufacturing and construction. Some precious metals, such as gold and silver, are also used in jewelry and for investment purposes.

Examples of metal commodities include:

  • Gold
  • Silver
  • Platinum
  • Copper
  • Nickel
  • Aluminum
  • Palladium

Energies

Energy commodities play a crucial role in the global economy. Without energy sources, people would be unable to use transport, produce goods, heat their houses, or cook meals.

Examples of energy commodities include:

Agriculture

Agricultural commodities are crops grown on farmlands and products derived from farm animals. Most agricultural commodities are used to produce food. However, some of them, for example, cotton, can be used in industries.

Examples of agricultural commodities include:

  • Sugar
  • Cotton
  • Cocoa
  • Wheat

Commodity Price Movements

In its most basic form, commodity prices fluctuations are based on demand and supply ratio.

If the global demand is higher than the supply, the price will rise. In the reverse situation, the price will fall.

However, in order to determine what drives demand and supply, you need to have deeper understanding of the fundamentals influencing geopolitical and economic factors.

Supply

Key drivers of commodity supply include:

  • Government intervention. Governments can play a key role in commodity supply. For example, since 2020, the United States have been releasing oil from its strategic reserves to control supply in the domestic market and prevent oil price growth.
  • Geopolitical events. Conflicts between countries, terrorist attacks, trade wars, social unrest, and closures of important transport routes can reduce commodity supply and, hence, push the prices up.
  • The weather can also play a major role in the supply of agricultural commodities such as sugar, wheat, cotton, and cocoa. These kinds of commodities require consistent weather cycles for producers.

Example:

The Organization of the Petroleum Exporting Countries (OPEC) controls 2/3 of global oil reserves. Thus, it can have a great effect on oil prices. If OPEC wishes to increase global oil prices, it can collectively agree to reduce production. On the other hand, it can collectively agree to increase output levels to pull the prices down.

On Monday, September 5, OPEC decided to cut oil production by 100 000 barrels per day. As a result, Brent (XBRUSD) lost 9% by the end of Wednesday’s trading session.

XBRUSD lost 9 percent.png

Demand

Key drivers of commodity demand include:

  • Health of global economy. During periods of strong economic growth, demand for many commodities tends to be high as there is more construction and manufacturing activity. Conversely, during periods of weak economic growth, commodity demand tends to be lower as construction and manufacturing activity declines.
  • Growth in the emerging markets. Fast-growing emerging market countries such as China and India are major sources of commodity demand. These countries need commodities to build infrastructure, fuel their factories, and feed their growing populations. During economic expansion in emerging markets, commodity demand tends to be high.
  • Consumer trends. Changes in consumer behavior also play a key role in commodity demand. For example, rising demand for jewelry can boost demand for gold. Similarly, car demand can impact the demand for platinum, as the metal is used to make catalytic converters, which help reduce vehicle emissions.
  • Manufacturing trends. Demand can be impacted negatively by commodity substitution due to the rising prices. Buyers will look for cheaper alternatives if a particular commodity becomes too expensive. A good example here is copper, which is used for a wide range of industrial applications. As copper prices rose, many manufacturers starting using aluminum as a substitute.
  • Strength of the US dollar. Most commodities are priced in US dollars. When the US dollar falls, commodities become less expensive in other currencies, increasing demand. Historically, the prices of commodities used to rise when the US dollar value has weakened against other major currencies. This inverse relationship doesn’t hold all of the time, however.

Example:

Oil prices fell by more than $4 a barrel on August 15 on demand fears as disappointing Chinese macroeconomic data renewed global recession concerns. China is the largest oil consumer in the world. Thus, a slowdown in Chinese economy drops the oil demand as the country needs less energy due to the production slowdown.

crude oil drops.png

You can attempt to predict future commodity price movements by following relevant news surrounding your preferred asset.

Trading commodities with CFDs

There are many ways to trade commodities. However, one of the easiest ways is using Contracts For Difference (CFDs). CFDs are financial instruments that offer traders and investors the opportunity to profit from the price movements of a security without actually owning the underlying security.

Trading commodities through CFDs has several advantages:

  • CFDs enable you to profit from price movements of a commodity without taking delivery and keeping the commodity itself.
  • CFDs enable you to use leverage to increase your trading capital.
  • There are typically no transaction fees associated with CFD trades. The main fee traders pay is the "spread" between the buy and sell prices of the trade.

How to Trade Commodities – 6 Quick Steps

If you want to learn trading commodities right now – follow the simple 6 -steps outlined below:

  • Choose an online broker. You will first need to choose an online broker that enables you to trade commodities. FBS offers a wide range of commodities, low fees, and small account minimums.
  • Deposit funds. You can start trading commodities on a cent account, requiring a minimum $1 deposit. No deposit fees are charged on USD payments, and you can fund your account by a bank wire, debit/credit card, and several other methods. 
  • Choose a trading platform. With FBS, you can trade commodities using a web trader, MetaTrader 4, Meta Trader 5, and FBS trader mobile app. Pick the best platform that fits your preferences and install it on your device. 
  • Study the market sentiment. Commodities are often volatile, so before you place a trade, make sure you research the respective market. You'll need to consider fundamental research methods surrounding demand and supply, geopolitical events, broader economic indicators, and more.
  • Choose commodity to trade. When you are ready to start trading commodities, choose the best commodity to trade, depending on the macroeconomic situation. 
  • Start trading. Enter the market by buying or selling the chosen asset. Remember, the commodities are highly volatile, so do not forget to follow risk management rules and place stop-loss orders.

Risks of trading commodities

Any form of investing or trading involves risks, and commodity trading is no different. Two of the main risks to be aware of with commodity trading are:

  • Price risk. Commodity prices can be highly volatile, and while this volatility can create trading opportunities, it can also be a risk factor. Unfavorable price movements can result in significant losses for traders. If you do not have sufficient funds in your account to cover potential losses, your positions may be automatically closed.
  • Leverage risk. While leverage is a powerful tool that can magnify trading gains, it can also work against you by magnifying trading losses. If a large amount of leverage is used for trading, even a relatively small price movement in the wrong direction can result in substantial losses. It’s important to be aware that losses can exceed the amount invested.

Best commodities to trade

Gold

There're multiple reasons why gold is the best commodity to trade. First and foremost, in terms of trading volume, gold attracts significantly more action than any other commodity.

Moreover, gold price reacts to different kinds of events, from monetary policy reports to military conflicts. Therefore, price volatility offers traders many trading opportunities. 

Oil

Oil is commodity is used in largest volumes globally, so it is only logical that it is a great asset class to trade.

As mentioned, oil prices are determined by demand and supply, which OPEC usually manipulates.

However, rising tensions in the Middle East or economic sanctions on major oil-producing countries like Russia and Iran can increase oil price volatility.

Natural Gas

Just like oil, natural gas is one of the most volatile commodities to trade. Moreover, natural gas prices are also dictated mainly by geopolitical events. With many western governments announcing that they will ban or reduce natural gas imports from Russia due to its invasion of Ukraine, this commodity has since seen a significant pricing rally.

Summary

Commodity prices are impacted by supply and demand. Supply can be affected by government policies, geopolitical events, and the weather. Demand can be affected by the health of the economy, growth in emerging markets, consumer trends, manufacturing trends, and the strength of the US dollar.

The commodity market is one of the favorites among forex traders as the price’s volatility offers many trading opportunities from day to day. To improve results in the commodity market, a trader needs to follow the news and be aware of the overall macroeconomic sentiment.

However, the high volatility of these instruments might be dangerous for newbies. Therefore, traders should always follow risk management and use stop-loss orders in every trade. 

Questions about commodity trading

What are Commodity Trading Hours?

Commodities are available to trade 24/5, opening on 00:00 GMT+3 on Monday, and closing at 00:00 GMT+3 on Saturday.

How to trade crude oil and natural gas with FBS?

To trade oil and gas online, you need to open an account with a reliable and licensed broker such as FBS. Then go to MetaTrader 5 or the FBS Trader app and find the energies you want to trade: Brent (XBRUSD), WTI (XTIUSD), or gas (XNGUSD). You can trade energy commodities in both directions. For example, if you think Brent spot price will rise, open a long (buy) position. If you think it will fall, open a short (sell) position.

With FBS, you can trade crude oil and natural gas on favorable terms—zero commission, competitive spreads, and 1:200 leverage. Open a Standard or Cent account to try crude oil trading!

How Can I Start Trading Commodities?

If you would like to learn trading commodities right now – follow the simple 6-steps:

  • Chose an online broker
  • Open an account and deposit funds
  • Chose a trading platform
  • Research the markets sentiment
  • Choose commodity to trade
  • Start trading.

What Software is Used for Commodities Trading?

With FBS, you can trade commodities using a web trader, MetaTrader 4, MetaTrader 5, and FBS trader mobile app. Pick the best platform that fits your preferences and install it on your device.

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