How to Trade Commodities – Ultimate Guide 2024
Trading commodities is one of the most popular ways of profiting from the global exchange of goods.
Commodities are a great asset to diversify your portfolio and benefit from changing macroeconomic trends.
To be a profitable commodity trader, you need to understand all the different commodities and how they interact with each other, as well as the investment vehicles and your disposal.
In this article, you’ll find all you need to know about what are commodities and how to invest in them.
Ready? Let’s go.
How to trade commodities in 3 easy steps:
Step 1: Open a commodity trading account
It was not until after the establishment of the Commodity Futures Trading Commission (CFTC) and the passage of the Commodity Futures Modernization Act in 2000, that commodities started trading online. Before this, you could only buy or exchange commodities at the Chicago Mercantile Exchange (CME) or a few other over-the-counter exchanges. Since then online commodities, trading has evolved tremendously. Its no longer a preserve of the elite investors as different online trading platforms have introduced the trade to retail investors.
Today, numerous online trading platforms offer commodity futures trading. So what do you look for when registering with an online commodity trading brokerage? First, ensure it is registered and regulated by the CFTC. You will also want to consider the brokers trading fees and commissions, the number of commodities supported, trading platforms supported, and their ease of use as well as the minimum deposits.
To help you register a commodity trading account with the right broker, we have reviewed the online commodity trading industry and recommended these three top trading platforms:
1. E*TRADE – Competitively priced commodity trading fees
A technologically advanced platform with pro-level tools that include 100+ technical indicators, Competitive pricing, great customer support, and a large number of commodities to choose from are some of factors characterizing E*TRADE. The trading platform is hosted on the Power E*TRADE web and mobile app versions that allows for 24-hour trading, six days a week.
Most of the commodities listed on the platform are listed with some of the most popular commodity exchange markets like the CME, ICE, and CFE.
The trading platform also features great education and research materials to help both beginner and veteran traders perfect their trade. You also have access to the commodity markets in real time while benefiting from the fastest trade execution speeds.
- Traders get to benefit from commission free trades and competitive trading fees
- Broker will only list reputable commodities traded in high-profile physical commodities exchanges like CME and ICE
- Boasts of having a highly advanced trading platform with some of the fastest trade execution speeds
- Broker assisted commodity trades can be extremely expensive
- Charges higher rates for use of margin than other online brokers
2. IG Markets – Best for premium services from personal account managers
IG Markets appeals to both the smallholder members as well as the high volume day traders. The broker maintains one of the most sophisticated but also easy to use trading platform. The trading fees are competitively low, features a broad array of tradable commodities, and is equipped highly innovative trading, market research, and risk management tools.
The education and training resources and highly supportive customer support also come in handy to help a beginner launch a successful commodity trading career on the platform. Active high volume traders, on the other hand, get to benefit from such premium services as highly personalized market analysis reports as well as affordable personal account assistance from its veteran commodity trading professionals.
- IG Markets hosts one of the most advanced and most beginner friendly trading platform
- The brokers supports a wide range of payment processing methods
- Hosts a wide range of popular commodities
- Maintains inactivity fee
- No phone support
Step 2: Learn How to Trade Commodities
What are commodities?
Commodities are raw materials and basic goods used in commerce and industry to build more complex products and services.
Commodities are fungible, which means that they can be standardized and exchanged among them. This means that, for instance, two tons of wheat will have almost the exact same price anywhere on the planet.
One particular characteristic of commodities is that they are produced and traded in large quantities, guaranteeing a global supply and enough liquidity for the market.
There are four main types of commodities:
- Energy: these commodities include crude oil, electricity, natural gas, coal, uranium, gasoline, heating oil, and ethanol. Energy commodities have a massive impact on the production, distribution, and price of other commodities.
- Agricultural: all food crops (wheat, corn, soybeans, barley…), industrial crops (cotton, rubber, lumber…) and livestock (cattle, poultry, hogs…).
- Metals: precious metals (gold, silver, platinum, and palladium) and base metals (iron ore, steel, aluminum, nickel, zinc, tin…).
- Environmental credits: this is the newest category of commodities, including carbon emissions, renewables energy certificates, and energy-saving certificates.
How commodities work
Depending on the category, each commodity will have particular factors that influence its supply and impact its price.
The main factors that drive commodity prices are:
Like any other asset in the market, commodity prices are inevitably driven by the available supply at a given moment.
If you want to trade agricultural commodities, you have to bear in mind crop yields, climate episodes like floods or droughts, global politics, and labor issues. For instance, if French winemakers go to strike, it may affect wine prices globally.
The other side of the coin of commodity prices is global demand. In the case of the commodities, you have to consider which economies are more dependent on raw materials, as well as those countries who produce them.
A good example of this is China, a populous country that is rapidly becoming wealthy. A downturn in the Chinese economy would affect commodity prices globally, hugely in countries that export raw materials to the Chinese market, like Australia.
Weather is a massive force in determining the supply and demand of commodities.
Heatwaves trigger the use of air conditioning, shooting up the demand for electricity. Hurricanes impact oil drilling and transport. Too much rain, or too little, impact crop yields.
You better keep an eye on the weather news if you want to be a profitable commodity trader.
iv) US Dollar
The American Dollar has been the world’s currency reserve for a few decades, so its performance has always an impact on commodity prices.
A strong dollar translates in lower commodity prices, as countries producing raw materials get fewer dollars for their sales. A weak dollar, in return, leads to higher commodity prices.
When possible, the market players will try to use the cheapest commodity available.
You can’t use zinc instead of gold, but silver does the trick. A spike in the price of soybeans may translate into farmers switching to corn to feed their cattle. You have to bear in mind this economic principle if you plan on investing in any commodity.
Step 3: Commodity trading strategies
There are many strategies to trading commodities, but if you are a starter, you should focus on these two:
Traders use fundamental analysis to identify which factors influence the forces of supply and demand.
As mentioned above, commodities are impacted by tens of factors, so it’s imperative to do deep research to identify opportunities with strong fundamentals.
Fundamentals that affect commodities are, above all, production levels. Inventories and production output are great fundamental tools.
Macroeconomic data, like GDP growth, unemployment or interest rates offer solid data for fundamental analysis.
Some traders believe that fundamental analyses are not important, as the market has already priced them. They focus on studying price charts to identify price levels that were reactive in the past and maybe so again in the future.
There’s plenty of literature around technical analysis, if you are totally new, you can start here.
There is a big debate within the trading community about which kind of trading is better, although most traders use them both in a hybrid model.
Ways to trade commodities
There are plenty of options to trading commodities, here’s a list of the most popular:
Investment Storage Costs Expiration Date Management Costs Leverage Regulated Complexity (1= easy, 5 = hard) Physical Delivery YES NO NO NO NO 5 CFDs NO NO NO YES YES 3 Futures NO NO YES NO YES 5 Options NO YES NO YES YES 5 ETFs YES NO YES NO YES 2 Shares NO NO NO YES YES 2
- Physical Delivery
You can buy any commodity and store it, although this may be unrealistic for retail investors. Purchasing large quantities of commodities require storage costs, as well as insurance and management.
A way of achieving this would be purchasing gold bars, but even this would require a certain level of secure storage.
Futures are contracts that specify a date and price for buying or selling a certain amount of a given commodity. These contracts typically involve large quantities of product and high margins.
Commodity futures are reserved for professional traders, although retail investors can access this trade via Commodity CFDs.
As with most options contracts, the trader is buying the right to buy or sell some commodity at a given price during a given period of time, but not the obligation. Options contracts are paid at a premium price and their underlying asset is commodity futures, rather than a physical commodity itself.
Like any other Exchange-traded fund, Commodity-based ETFs are funds that track the performance of futures or a group of equities.
ETFs have become a popular investment, in part because they generally don’t invest in securities, hence commodity ETFs are not regulated as investment companies.
There are some ETF that follows what is called a basket of commodities, which reduces the risk of putting all the eggs in the same basket.
This is one of the most traditional ways of investing in any commodity. Here you just buy equity on companies with the aim of obtaining a profit after the appreciation of the shares. This can be any company, from a farm to an oil refinery.
CFDs are contracts that exchange the difference between the entry price and the exit price on a trade. CFD stands for “Contract For Difference.”
Oil CFDs can be very popular because they enable every investor to speculate on the fluctuations of the commodity price with small contract sizes. CFDs are usually free of commission and borrowing costs, as there is no ownership of the underlying asset.
The way CFDs work is that the investor borrows some money to increase the exposure to the asset, in the hopes that the price will move in their favor and they could exit the trade making a profit out of the spread.
The formula to calculate the total value of a CFD is as follows. The below is NOT a trading recommendation. Do your own research before investing.
For this example, let’s assume that the price of a metric ton of wheat is $200. The standard number of metric tons in a contract is 100, and you want to buy 10 long CFDs at a 5% margin because you’re confident that the price will go up.
You’ll need to have a balance of $10,000 in your account to execute this trade. This will allow you to control $100,000 worth of wheat (10 contracts of 100 barrels each).
Let’s say that the price goes to $210. Now you control $105,000 of wheat, and you exit the trade, having made a profit of $5,000. Bear in mind that if the price goes down instead, the same rule of leverage works against you and you may lose some of your money or, in the worst case, your account may get liquidated.
If you want to try a CFD provider, we recommend you to have a look at Plus500.
Step 4: Execute your first commodity trade
If you want to start buying and selling commodities right away in the most user-friendly trading, we recommend that you register with a major broker of your choosing.
After a quick signup process, you should be good to go. Just do your research before about how well the broker handles commodity trading.
The pros and cons of commodities
Why you should consider trading commodities
The three main reasons for getting now into commodity trading are portfolio diversification, hedge against inflation and population growth.
i) Portfolio Diversification
Most investors have their portfolios filled with stocks and bonds. Adding some commodities makes your portfolio much versatile against possible macroeconomic swings.
ii) Inflation Hedge
We have seen the central banks around the world keeping a low-interest rate policy during the last couple of decades. This keeps inflation down, creating bubbles in assets like stock.
Sooner or later, the world will enter an inflationary season, and this will drive commodity prices up.
The rise of new geopolitical powers like China, the EU and India, and a multipolar world may weaken the current system of American dollar hegemony. A weaker dollar will most likely shoot up the price of most commodities.
iii) World Population
If the two previous points weren’t enough, check out the estimated population by the UN:
Even in the most conservative estimates, we will have around 9 billion people by 2050. Just by itself will drive up the price of crops, cattle, and textile-related crops.
As emerging countries grow wealthier. Their population will start consuming at the level of current rich countries.
Another issue to consider is the rapid rate of urbanization in the developing world. As millions of people leave the countryside to live in big cities, the demand for metal and energy will shoot up.
Glossary of commodity TermsPlatform Fee
The trading platform fee refers to the amount a trader pays to use the platform and access its integrated platform features and tools. It can be a one –time fee paid for the acquisition of the trading platform, a subscription fee paid monthly or annually. Others will charge on a per-trade basis with a specific fee per trade.Cost per trade
Cost per trade is also referred to as the base trade fee and refers to the fee that a broker or trading platform charges you every time you place a trade. Some brokers offer volume discounts and charge a lower cost per trade for voluminous trades.Margin
Margin is the money needed in your account to maintain a trade with leverage.Social trading
Social trading is a form of trading that allows for the interaction and exchange of trade ideas, signals and trade settings between the different classes of traders.Copy Trading
Copy trading, also known as mirror trading is a form of online trading that lets traders copy trade settings from one another. In most cases, it is the newbies and part-time traders that copy the positions of pro traders. The copiers -in most cases - are then required to surrender a share of the profits made from copied trades – averaging 20% - with the pro traders.Financial instruments
A Financial instrument ideally refers to the proof of ownership of financial commodities of monetary contracts between two parties. In the money markets, financial instruments refer to such elements as shares, stocks, bonds, Forex and crypto CFDs and other contractual obligations between different parties.Index
An index is an indicator that tracks and measures the performance of a security such as a stock or bond.Commodities
Commodities refer to raw materials used in the production and manufacturing of other products or agricultural products. Some of the most popular commodities traded on the exchange markets include energy and gases like oil, agricultural products like corn and coffee, and precious metals like gold and silver.Exchange-Traded Funds (ETFs)
An ETF is a fund that can be traded on an exchange. The fund is a basket containing multiple securities such as stocks, bonds or even commodities. ETFs allow you to trade the basket without having to buy each security individually.Contract for difference (CFD)
CFDs are a form of contractual trading that involves speculating on the performance of a particular trade in the market. CFD’s will basically allow you to speculate on the future value of securities such as stocks, currencies and commodities without owning the underlying securities.Minimum investment
The minimum investment simply refers to the lowest amount of capital injection you can deposit into a brokerage or a trading platform. Different brokers demand varied minimum investment amounts from their clients either when registering or opening trade positions.Daily trading limit
A daily trading limit is the lowest and highest amount that a security is allowed to fluctuate, in one trading session, at the exchange where it’s traded. Once a limit is reached, trading for that particular security is suspended until the next trading session. Daily trading limits are imposed by exchanges to protect investors from extreme price volatilities.Day traders
A day trader is a term used to describe a trader who is constantly opening trades and closing them within a day. It is a common term used to refer to forex traders who open trade and only hold onto it for a few minutes or hours before disposing and having to leave no open trades at the time the trading day closes.
What commodity traders do?A commodity trader is an individual or business that focuses on investing in physical substances like oil, gold, or agricultural products. The day-to-day buying and selling are often driven by expected economic trends or arbitrage opportunities in the commodities markets.
What is the meaning of commodity trading?Commodity trading is very similar to stock trading or bond trading, with the difference that in this case, the trader operates with a range of raw materials known as commodities.
How much money does a commodity trader make?According to a report published by the HC Insider in 2013, commodity traders with around three years experience earned an average salary of $100,000 to $150,000. Traders with more than five years experience had average base salaries of $200,000 to $350,000.
Are commodities high risk?Commodities are risky assets. Like any other type of trading, you should do thorough research before investing your hard-earned cash. This is especially important when trading commodity futures markets, where the leverage afforded by margin makes price risk the danger on which most people focus.
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