How to Start Commodity Trading [A Beginner’s Guide to Commodities]
Did you know that commodity trading dates back to ancient civilisation?
As far back as 4500 BCE in Sumer (now modern day Iraq), there was a commodity market. Locals would use clay tokens as a medium of exchange for goats. In 17th century Japan, rice merchants used to sell their stores of rice by selling 'rice tickets' (just like clay tokens) to willing buyers.
However, the global commodities market, and commodity trading itself really kicked off when the Chicago Board of Trade was set up in 1848. Now it is one of the most popular types of markets to trade on, from commercials, institutions and speculators alike.
Every person engages with commodities every day - from your morning coffee or orange juice, to the crude oil and gas that fuel your car and power your home. What you might not have realised is that, as raw materials, each of these is an asset that can be invested in, or traded, for a profit.
This article will provide you with a clear definition of commodities, their four main categories, what drives the commodities market, how commodity trading works, the different ways you are able to invest in them and much more.
What are commodities?
Before we answer the question, "What is the meaning of commodities trading?", we first must define 'commodity'. The definition of a commodity is a basic good or raw material that is used in commerce. These individual commodities are usually the building blocks for more complex goods or services. For example, sugar and cocoa are both soft commodities that are the building blocks of a chocolate bar.
What separates commodities from other goods is the fact they are interchangeable and standardised, with their values set by the relevant commodity exchange. This means that no matter who produces a commodity, or where it is produced, two equivalent units of the commodity will, more or less, have the same quality and price. So 500 grams of sugar will have the same value whether it is produced in India, Brazil or Thailand.
Historically, commodities were traded physically, whereas today, most commodity trading takes place online.
If you are ready to trade some of the most popular commodities online, you can do so with Admiral Markets! We offer a range of commodities for online trading via CFDs, including crude oil, natural gas, coffee, orange juice and even gold! Learn more about trading gold below.
What are the different categories of the commodity market?
Generally speaking, commodities are either extracted, grown or produced. There are four main categories that define the commodity market:
- Agricultural Commodities: This includes raw goods such as sugar, cotton, coffee beans, etc.
- Energy Commodities: This includes petrol products like oil and gas.
- Metal Commodities: This includes precious metals such as gold, silver and platinum, but also base metals like copper.
- Livestock Commodities: This includes pork bellies, live cattle and general livestock, as well as meat commodities.
You will also encounter terms like hard commodities and soft commodities trading. Hard commodities are mostly those that are mined (gold, oil, etc.) whilst soft commodities are agricultural or animals (wheat, soybeans, pork, sugar, etc.).
What are tradable commodities? As you can imagine, some commodities are traded more actively than others. For example, the Feeder Cattle market may only involve the farmer and the distribution company of the stock - thereby not producing that much trading activity. In fact, according to TradingView, the total trading volume of Feeder Cattle for September 2019 was 36,000 contracts. This number represents how many contracts, for the right to buy or sell feeder cattle, have been bought and sold.
However, a market like oil will involve public drilling companies, government backed drilling companies, service companies like BP and Shell, airlines who are actively involved in buying and selling oil to keep their fuel costs in check and, of course, speculators. According to TradingView, the total trading volume of Crude Oil for September 2019 was nearly 14 million contracts - a huge difference from Feeder Cattle.
Over the following sections, we will outline which commodities are the most commonly traded in the financial markets.
Coffee: Coffee is one of the world's favourite beverages with 2.25 billion cups being consumed a day. It is also one of the world's favourite commodity markets, being the second most-traded market after petroleum.
Sugar: Both white and raw sugar are traded as commodities. While most of us think of sugar as a sweetener, it also plays a key role in the production of ethanol. The market is predicted to grow at a compound annual growth rate of 2.9% to reach USD 89.24 billion in 2024.
Crude Oil: Crude oil is a popular commodity for trading because it can be very volatile. With the top producers of crude oil including Saudi Arabia, the US, Russia and China, this is a market that is very reactive to political events. Demand for this commodity is also high, because crude oil is used for transportation fuel, the production of plastics, synthetic textiles, fertilisers, computers, cosmetics and more. The major oil benchmarks are WTI and Brent Crude Oil
Natural Gas: This commodity has a range of industrial, residential and commercial uses, including generating electricity. The top natural gas producers are Gazprom, Royal Dutch Shell, ExxonMobil, PetroChina and BP.
Gold: Gold is another popular commodity. Known as a safe haven asset, gold is typically where investors put their money when markets are in turmoil. This means gold is often inversely correlated with the US dollar.
Silver: While gold is the most popular metal commodity for trading, silver also has some advantages. One of these is that the silver price tends to move a lot faster than the gold price, making it attractive for active commodity traders. Gold, on the other hand, has a higher value and is often seen as attractive for longer-term investors.
Copper: Copper benefits from consistently high demand, being used for electrical equipment, engineering, plumbing and cooking utensils. Its price is considered to be a reliable barometer of the global economy, so investing in copper is a way to take a bullish stance on world GDP.
Which commodities can you trade with Admiral Markets?
With Admiral Markets you have access via CFDs to sixteen of the largest commodities traded in the commodity market, plus 10 CFDs on commodity futures. Here is a list of the commodity CFDs currently available:
- Arabica Coffee
- Orange Juice
- Robusta Coffee
- Sugar Raw
- Sugar White
- Brent Crude Oil
- WTI Crude Oil
- Natural Gas
What drives commodity prices?
Each individual commodity has unique factors that affect its price. Huge price swings in the commodity market can occur when the scarcity or abundance of a commodity is threatened. Overall the biggest influence across all commodities boils down to changes in supply and demand, however, other elements like the US dollar, substitution and weather can also have an impact.
The supply of a commodity can be influenced by a multitude of factors, such as government intervention, weather, war, and so on.
For example, on 14 September 2019, a swarm of explosive drones attacked the world's biggest oil processing plant in Saudi Arabia, reducing global oil production by 5 million barrels a day. This accounts for nearly half of Saudi Arabia's current output and 5% of global production. The event triggered a record surge in oil prices.
When the market opened on 16 September, Brent Crude Oil spiked from 60.42 on the evening of 13 September to 72.19 at market open on 16 September - a jump of 19.4%. Over the same period, WTI Crude Oil leapt 15.5% - from 54.79 to 63.28.
Source: Admiral Markets MT5 Supreme Edition - WTI Daily Chart - Data range: 7 May 2019 to 12 December 2019 - Performed on 12 December 2019. Please Note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.
This surge in price was triggered because less oil was available in the marketplace but demand had remained the same as before. Therefore, commercials and institutions scrambled to get their hands on whatever oil was left. This type of 'scarcity' typically leads to price increases.
When it comes to commodities trading, it pays to remember that the supply of energy commodities are mostly affected by government policy (such as economic sanctions) and Middle Eastern tensions, as Saudi Arabia have one-fifth of the world's proven oil reserves.
The demand for a commodity can also be influenced by numerous factors, such as changes in consumer habits and the health of the economy. For example, many peoples habits around consuming sugar have changed. People are actively trying to consume less sugar. If enough people see it through, then demand shrinks accordingly. In the chart below, we can see sugar prices for an extended period:
Source: Admiral Markets MT5 Supreme Edition - Sugar.White Daily Chart - Data range: 19 April 2009 to 16 June 2020 - Performed on 16 June 2020 at 4:20 PM GMT
The yellow boxes in the chart above highlight the sharp declines in the price of sugar beginning in 2010. However, there was a move higher between September 2015 to September 2016, due to concerns over a global shortage. This was caused by a supply disruption to a Brazilian cane crop (which is the world's largest producer), which helped sugar to become 'scarce', and, therefore, causing prices to move higher.
However, in this particular instance, whilst a change in weather caused sugar prices to push higher during that period of time, the bigger issue of demand played out in the end, sending prices back down. This is one reason why trading commodity CFDs could have been helpful in this 'sugar' scenario.
Commodity demand - WTI example
Commodities can be also very volatile and trend in one direction for a long time.
A good example of that is how in 2020 West Texas Intermediate (Crude Oil) price went from nearly 65 USD per barrel to negative in 4 months. This was caused by many factors falling together at the same time, but mainly it was caused due to decreased demand for oil as the Coronavirus hit the global economy and therefore the majority of global transport was stopped.
At the same time, oil producers continued to produce nearly record levels of oil into the global market even as analysts warned that the impact of the coronavirus will decrease demand significantly.
All this has led to global oil storages being full and there was nowhere to store it. Simply put, in order to get rid of the oil, the oil sellers had to pay buyers to empty their storages.
Why did the producers keep oil production up?
Oil wells can't simply be turned off and on. It costs human resources and a significant amount of money to shut them down and even more resources to start them again. Oil producers have to keep production flowing, even if they are operating at a loss and for a short period of time, they were willing to pay in order for distribution companies to take oil.
Below you can see CRUDOIL chart trending down from 65 USD per barrel to negative territory for the first time in history.
At the time of writing this article, oil prices have retraced and are trading at around 37.60 USD per barrel.
Source: Admiral Markets MT5 Supreme Edition - CRUDOIL Daily Chart - Data range: 23 April 2015 to 06 June 2020 - Performed on 06 June 2020 at 8:31 PM GMT
With commodity CFDs, you can profit from a falling market, as well as a rising market, as long as you get the direction right. So, now you know a little more about the factors that drive commodity prices, as well as a popular vehicle to trade commodities from, how can you start commodities trading risk-free today?
With a risk-free demo account from Admiral Markets, you can trade thousands of the world's financial markets (including energy, metal and agricultural commodities) free! Simply click the banner below to sign up and start trading today!
Relationship between USD and commodities
Along with supply and demand, the behaviour of the US dollar can also influence commodity prices.
The US dollar is the world's reserve currency and, in international markets, commodities are priced in USD. This means that the prices of commodities are directly linked to the value of the dollar against foreign currencies. For example, if the value of the dollar drops against other currencies, it takes more dollars to purchase commodities than it does when the dollar is valued more highly.
In addition, gold is seen as a safe-haven asset, and is often where investors turn when the value of the USD goes down, particularly in times of economic turmoil. So gold not only benefits from being priced higher in USD, but it also benefits from further investment, which can lead to larger jumps than traders might see in other commodities.
Substitution simply means that markets will look for cheaper alternatives where possible. As a particular commodity becomes more expensive, buyers will look for cheaper options. If they find a suitable alternative, they will start purchasing that, which reduces the demand for the original commodity and can result in the price decreasing.
One example is copper, which is used in a range of industrial applications. As the price of copper has increased, many manufacturers have started using aluminium instead.
How weather affects commodity prices
Weather can also influence commodity prices. In particular, abnormal or unexpected weather changes like extreme rain or drought can have a significant impact on agricultural commodities. Simply put, commodities like cocoa, coffee and orange juice are harvested and grown, and therefore need consistent weather cycles.
Having said that, the weather can also influence energy commodity prices, as severe winters increase the demand for heating, which in turn increases the demand for heating oil and natural gas. The same goes for extremely warm weather, which increases the need for air conditioning. This raises the demand for the commodities involved in electricity production, like natural gas and coal.
Why should I trade commodities?
While there are a range of reasons to start trading commodities, there are three main reasons that make commodities an interesting investment for today's traders. These are the growing global population, inflation hedging and portfolio diversification.
Global population growth has exploded since the beginning of the twentieth century, with the global population now reaching 7.7 billion. While the annual growth rate is slowing, it's still sitting around 1% a year, which means that number will continue to climb.
Population growth then creates demand for infrastructure, which could have a significant impact on the demand for both metal and energy commodities. In addition, more people means there are more mouths to feed, which will affect the demand for agricultural commodities.
Ultimately, more people leads to more demand, which means that commodity prices are likely to continue to increase over the long term.
Inflation is the rate at which prices increase, and means that today's money will have less purchasing power in the future. In terms of commodities, it means it will cost more dollars to purchase the same amount of a given commodity in the future.
By investing in commodities directly, however, savvy traders can protect themselves from these price increases, and could potentially benefit from selling the commodities for a higher price in the future.
Many investors do not have a diversified portfolio. In many western countries, the bulk of a household's net worth is tied up in their property. Meanwhile, those who do invest tend to stick to stocks or bonds.
The issue with this is that if the market in which you are investing has a downturn (e.g. if the real estate or stock market crashes), your portfolio will take a significant hit. On the other hand, if you have invested in a range of assets the individual investments in falling markets will be affected, but the overall portfolio will be insulated, as other markets will remain stable or might even climb.
Commodities are one asset class that can be added to your portfolio to create diversification and better manage risk.
How did the commodity markets develop?
While the precise birthdate of commodities trading is hard to pinpoint, many believe that commodity trading is as old as human civilisation itself.
One example of commodity trading is the trading of rice as the first commodity in China, 6,000 years ago. Another is when the Sumerians began using clay tokens to purchase livestock between 4,000 and 4,500 BCE.
It was the Greeks and Romans, though, who chose gold and silver as their preferred currencies, which meant that these became the first widely traded commodities of the ancient world.
It wasn't until a few centuries ago, however, that the modern commodity market began to develop through futures trading.
Futures are contracts that allow two parties (a buyer and a seller) to agree to make a transaction at a future date at a set price. This price is set regardless of the market value of the asset at the expiration date of the contract.
The most well-known example of historical commodity futures trading was in the 1800s in the US, when Midwestern farmers would bring their grain crops to Chicago for storage before they were due to be shipped to the East Coast. However, while they were in storage, the prices for these grains was subject to change. This might be due to an increase in supply or demand, or the quality deteriorating in storage.
Rather than being vulnerable to unexpected price changes, the parties involved created forward trading contracts in commodities that required the seller to deliver a certain amount of grain for an agreed-upon price at the expiration date of the contract. In exchange for this obligation, the seller would be paid upfront for the grains.
Unfortunately, these forward contracts weren't very efficient, and also left the buyer carrying most of the risk due to the seller being paid upfront. With this in mind, commodity futures contracts were developed, which kept the terms defining the commodity to be delivered, the expiration date and the delivery terms. The difference was that these contracts were established via a centralised clearing house, the Chicago Board of Trade, who would act as a counterparty to both the buyer and seller in the transaction, which eliminated the risk of default.
For the next hundred years, agricultural products were the primary commodities traded on futures exchanges. However, in the mid-1900s, cotton, lard, livestock and precious metals were gradually introduced to the exchanges.
It wasn't until the 1970s that new financial products began to be developed - products that allowed people to speculate on the changing prices of commodities, without having to purchase or sell the physical commodity. Later on, as people began working in commodities trading jobs, the commodities and futures trading commission was created and after this, with the advent of the internet, people began engaging in commodities future online trading. Today, there are several commodities trading company LLC, commodities trading corporations and the like, including Macquarie commodities trading, VTB Group commodities trading and Zenrock commodities trading.
If you are ready to start trading, one of the first steps is downloading a trading platform.
MetaTrader 5 is the world's number 1 multi-asset trading platform, which you can use to monitor and trade thousands of markets - shares, Forex, cryptocurrencies, and commodities. The good news is that you can download it now, absolutely free!
To download MetaTrader 5, click the banner below and start trading the live markets today.
How can I start commodities trading?
There are a number of ways you can trade commodities: investing in the physical commodity itself, trading commodity futures, trading commodity options, trading commodity ETFs, trading commodity shares and trading CFDs on commodities. We will outline each of these options below.
Investing in physical commodities
One way to invest in commodities is to go directly to the source and purchase the goods themselves (e.g. purchase oil, gold or sugar directly). Over time, if prices rise, you could find a buyer and pocket the difference in profit.
But is it really that feasible for you to go and find a producer and seller of oil, or sugar, to buy the goods from? You would then have to find a buyer for your goods as well. And you will have to store your goods, as commodities are physical products!
Producers of sugar only sell in quantities of 112,000 pounds. That's about eight and a half times the weight of an elephant. Could you store that much? It's quite unlikely! Also, let's not forget the fact that volatility in commodities tends to be higher than with stocks and bonds, as there are more supply and demand issues affecting the price.
In addition to physical storage space, you would need to consider other storage factors. For example, if you were to buy precious metals (fortunately, these are available in smaller quantities than sugar), you would need a secure storage facility, which increases the cost and complexity of your investment.
Trade commodity futures
As we discussed earlier, futures are contracts where a seller agrees to sell a fixed quantity of a certain commodity at a fixed price on a particular day in the future to a buyer.
Historically, at the expiration of the futures contract, the commodity would change hands from the buyer to the seller. However, today many traders use futures as a vehicle for speculating on commodity prices and have no intention of taking ownership of the actual commodity once the contract expires.
Simply, if the commodity price rises between the purchase date of the contract and the expiration date of the contract, the trader can sell the futures contract at a profit. If the price falls, the trader will make a loss.
One of the benefits of trading commodity futures is the use of leverage, which allows traders to make a larger trade than what they could purchase outright with their available funds. For instance, if a futures contract is offered with leverage of 1:10, this means that for each dollar the trader is willing to invest, they can access $10 worth of the commodity in question.
This can amplify trading profits, but can also amplify trading losses. Learn more about leverage here.
While leverage can make futures trading attractive to new traders, futures trading is highly complex as there are many factors to take into consideration when evaluating market pricing and predicting the direction in which it will move. For instance, along with looking at the current price of a commodity, it is also important to consider the cost of storage and interest rates and how they might influence commodity prices.
Like futures, options are another type of derivative that allows you to trade on the changing value of a commodity without having to purchase the commodity outright. Options can also benefit from leverage.
There are two types of options contracts - calls and puts.
The owner of a call option has the right but not the obligation to buy a commodity futures contract at a set price (the strike price) on or before a certain date (the expiration date). The owner of a put option, on the other hand, has the right but not the obligation to sell a futures contract at the strike price on or before the expiration date.
If the price of the future becomes higher than the strike price, a call option can be sold for a profit. For a put option, the reverse is true - the price of the future needs to fall below the strike price.
This means options traders not only need to consider how market pricing will change in their strategy, but also the timing of those changes.
An ETF, or an exchange-traded fund, is a fund that invests in a group of financial assets. As a trader, you can invest in these funds via a broker or on a stock exchange.
ETFs are most well-known for containing bundles of stocks, however, some ETFs invest in physical commodities like gold bullion, while others invest in commodity futures or options.
With this in mind, the risks involved with trading ETFs mirror the risks of the assets they contain. ETFs that invest in physical commodities will carry similar risks to investing in physical commodities, while those that invest in futures carry similar risks to buying futures directly.
One of the main advantages of investing in commodity ETFs is the diversity that comes with investing in a range of assets via a fund, rather than picking individual assets to invest in. However, this can also mean you miss out on large movements that take place in individual commodities.
By 'commodity shares', we mean the shares of companies that produce commodities. The theory is that these companies' revenues are based on the price of the commodity they are selling - if the price of the commodity increases, so too should a company's revenues and its share price.
The challenge with this approach is that there are risks to a commodity producer's share price in addition to the factors that can influence commodity prices. These include:
- Market competition
- Costs of doing business
- Interest rates
- Local economy performance
- Price/earnings growth/contraction
Like options and futures, CFDs (Contracts for Difference) are another derivative instrument that can be used to trade commodities.
CFDs allow traders to speculate on the changing prices of commodities, and other assets, without ever owning the commodity in question. They were originally developed in the early 1990s in London, by two investment bankers at UBS Warburg.
Essentially, a CFD is a contract between two parties - the trader and the broker. At the end of the contract, the two parties exchange the difference between the price of the commodity at the time they entered into the contract, and the price of the commodity at the end.
So if you opened a long (buy) CFD trade on gold when gold was priced at $1,525, and you closed the trade after the price of gold rose to $1,550, you would make a profit on the difference in the gold price, or $25. If the price fell to $1,500, you would make a loss of $25. In simple terms, the trader is paying the difference between the opening and closing price of the commodity they are trading.
The simplicity of entering and exiting positions, compared to other trading vehicles like options and futures, is just one reason why trading commodity CFDs is very popular. That's not to say it's easy, but there are certain benefits, such as:
- Leverage - a retail trader can trade positions twenty times their account equity. A professional trader can trade positions five hundred times their equity.
- 24h/5d - traders can trade twenty fours a day, five days a week, accessing opportunities from a variety of commodities all around the world.
- Zero commission - traders can trade with zero commissions, and can start with just 200 euros in their account.
- Profit from a rising and falling market - if you get the direction right of course! Otherwise, losses can occur.
However, there are even more benefits to trading commodity CFDs with Admiral Markets, such as:
- Negative balance protection policy, which means that if your account balance drops below 0, Admiral Markets will reset it at 0, rather than letting you fall into trading debt
- Low trading costs, including spreads from 0 pips
- A free, premium analytics portal that includes news feeds from Dow Jones newswires with up to 850 articles a day, market sentiment widgets, economic calendars and more
- Access to the world's most popular trading platforms, MetaTrader 4 and MetaTrader 5
Having the right platform and a trusted broker are hugely important aspects of trading. Admiral Markets is an award-winning broker that offers the ability to trade on commodities via CFDs, not to mention other markets like Forex, stocks and ETFs and much more.
This is all made possible with the state-of-the-art trading platform MetaAdmiral Markets offers MetaTrader 4 and MetaTrader 5 with the exclusive MetaTrader Supreme Edition plugin.
With MetaTrader Supreme Edition, traders have access to a range of additional tools to boost their trading, including an indicator package of 16 new indicators, technical insight and trading ideas provided by Trading Central, and the new trading terminal, which provides advanced trading features like partially closing trades.
To download MetaTrader Supreme Edition for free, click the banner below!
Commodity CFD example
Let's look at a commodity example trade. You think the price of Brent crude oil is going to fall, so you decide to open a sell, or short, trade. Essentially, you would open the trade at one price and if the price fell, you would close the trade and pocket the difference as profit.
In this example, the market price of Brent crude oil is $72.22 per barrel. One lot (the standard size of a CFD) is 1,000 pounds. Therefore, the value of one lot of Brent would be $7,222.
The available financial leverage you have is 1:10, so to open a trade on one lot, or $7,222, of Brent crude oil, you would need to have $722 on your trading account. ($7,222/10 = $722).
If you opened a short commodity trade at 72.22, and then closed it at 53.46 cents per pound, the difference between the opening price of the trade and the closing price of the trade would be $18.76.
Depicted: Brent crude oil Daily Chart - Admiral Markets MetaTrader 5. Data Range: April 30, 2019, to June 16, 2020 - Performed on June 16, 2020. Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
Depicted: Brent crude oil Weekly Chart - Admiral Markets MetaTrader 5. Data Range: November 9, 2014, to June 16, 2020 - Performed on June 16, 2020. Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
To figure out your profit, you would need to multiply that price difference by the size of the trade, and by the value of a one-point movement. Both the contract size and point value vary for different commodities, so it's important to be aware of this in advance.
In this case, your trade was one lot, or 100 barrels of the commodity Brent crude oil. This gives us:
(72.22 - 53.46) x 100 = $1,876
18.76 x 100 x $1 = $1,876
So you would make a profit on the trade of $1,876! Just remember that if the price of Brent had gone up rather than down, you would have made a loss.
The formula for calculating your profit/loss is the same for every commodity - price difference x contract size x value of a one-point movement. Just remember that the contract size and point movement values are different for each instrument, so need to be considered in your trading strategy.
It's important to keep in mind that your trading profit isn't simply the difference between the opening and closing price of the trade - you also need to consider the costs of trading.
When trading commodity CFDs, there are three potential costs to consider:
- Spreads: The spread is the difference between the bid (buy) and ask (sell) prices of a financial instrument. For example, if the bid price of the Gold is 1491.58, and the ask price is 1491.78, that is a difference of 0.20. For a trade to be profitable, it will need to cross this spread.
- Swaps: If you keep trades open overnight, a fee or adjustment gets charged at 23:59 in the platform's time zone.
- Commissions: Some instruments are also charged a commission for opening and closing trades. At Admiral Markets, Share and ETF CFDs, Shares and ETFs, and Forex and commodities in our Zero.MT4 account are charged commissions.
So, to calculate your commodity trading profit, you'll need to subtract the cost of trading from the formula above. This is a point that new traders often forget to consider before making their first trade. An effective trading strategy takes this into account and helps you avoid entering the wrong trades.
How can I improve my commodity trading results?
I have now introduced commodities and shared the different ways you can trade them. However, I haven't covered what it takes to successfully invest in or trade commodities.
While there are no guarantees, there are a number of things you can do to improve your chances of success when trading commodities. These include:
- Get educated
- Analyse the market
- Manage your risk
- Diversify your portfolio
Let's take an in-depth look at each one:
1. Get educated
A demo trading account is another good way to learn how to trade - particularly when it comes to the mechanics of opening and closing trades and seeing how the markets work. However, a demo account can't teach you about your trading psychology, or how you manage money, so it's important to make the leap to a live trading account when you feel ready.
2. Analyse the commodity market
To make successful commodity trades, it's important to understand the reasons you are making those trades. Why do you believe a commodity is going to go up or down?
Most commodity analysis falls into two categories: fundamental analysis and technical analysis.
Fundamental analysis focuses on analysing economic factors that could influence the price of different commodities - particularly those that relate to supply and demand, as we discussed earlier. This might mean paying attention to:
- Macroeconomic data, like trends in GDP, unemployment and retail sales. These are all clues about the strength of an economy, and is often related to the strength or weakness of industrial commodity prices.
- The strength of the end markets of different commodities, which will influence demand for those commodities.
- Level of supply, which can be assessed in reports like the USDA's Cattle on Feed report. This report indicates the future supply of cattle coming on to the market, and can offer clues about beef prices.
- Market cycles, such as whether the markets are in a bull or bear cycle. This involves long-term analysis of market trends to make judgements about what's happening today.
- Changing policies from large economies and how they might influence commodity demand.
As you can see, there are a lot of things to keep in mind! And, if you are not a full-time trader with a team of research analysts at your disposal, it may prove to be difficult to track weather formations and government policy.
That's why many traders also use technical analysis to help with their trading decisions. So what is technical analysis of the commodity market? It is simply looking at patterns and indicators on a price chart for a particular commodity, for clues on its future direction.
For example, one tool that is popular among traders is moving averages, as they help determine the overall direction, or trend of a market. Essentially, they calculate a user-defined number of previous closing prices to find the 'average' price of the market. This line is then plotted on the chart so the trader can see the average trend of prices, historically.
Depicted: Gold Daily Chart - Admiral Markets MT5 Supreme Edition. Data Range: May 1, 2019, to June 16, 2020 - Performed June 16, 2020. Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
In the chart above , the red moving average line represents the average of the last fifty bars. The green line represents the average of the last one hundred bars. What you'll notice is that when the price of bars are above the fifty moving average, and that is above the one hundred moving average, prices tend to get higher. This is just one type of free indicator, among many, available to use on the Admiral Markets MT5 platform.
3. Manage your risk
Many traders consider trading commodities - particularly commodity CFDs - because access to leverage means they can trade large positions with a relatively small deposit, and amplify their profits as a result.
However, it's important to remember that leverage magnifies losses to the same extent as profits, which means it increases the risk of this type of trading - particularly when compared with traditional investing.
This is why risk management is essential. There are a number of ways you can manage risk, and some common ones include:
- Effective money management: Don't trade with money you can't afford to lose.
- Sensible position sizing: A general rule of thumb is that a single trade shouldn't risk more than 2% of your account balance. So if you have $1,000 on your account, you wouldn't want to risk more than $20 per trade. If your account balance increases or decreases, so too will your maximum risk per trade.
- Using stop losses and take profits: Stop losses and take profits are automatic levels you set at which your trade will close, meaning you don't need to manually close it. A stop loss is designed to prevent you from losing more than expected - if an instrument moves too far against you, the trade will close. A take profit is the opposite - a trade will close automatically once it has achieved a certain level of profit.
- Following a clear strategy: Some new commodity traders open a number of random trades and hope one of them will work. Worse, if they lose, they might open larger and larger trades in the hope of recouping their losses in one big win. Instead, you should always follow a strategy - one that defines how much you will risk, when you will open trades and when you will close them.
Managing risk is an essential aspect of any successful trading strategy. By employing these methods in your trading strategy you can avoid taking on losses that you can't afford and finding yourself in a difficult situation. Often, new traders suspect it won't be hard to exit a trade when it's looking bad and to make other reasonable decisions as they enter new positions. However, a trader's emotions can overpower their decision making quite easily when they are in the middle of a trade. The power of their emotions is difficult to imagine when they are in the calm and collected state of mind before they have entered their first trade.
The best way to avoid making mistakes is by sticking to a risk management strategy.
4. Diversify your portfolio with commodities
Do you know the expression 'don't put all your eggs in one basket?' It is very relevant when investing - you don't want to put all of your funds into one asset, or one market, because if it goes down you could lose everything.
Instead, it's important to build a portfolio that tracks a wide range of assets, including commodities. So you might have a portfolio that includes:
- Metal commodities like gold and silver
- Energy commodities like natural gas and crude oil
- Agricultural commodities like sugar and coffee
- Shares from a range of markets - the US, Europe, Asia-Pacific
- Indices, representing entire markets
- And more!
The good news is that you can invest in all of these markets via CFDs with Admiral Markets.
Choosing a broker
If you're looking for a broker to start trading commodity CFDs, there are a number of things to keep in mind to ensure you not only choose a legitimate, reputable broker, but also that the broker is offering the best possible conditions and tools to help you get the best trading results.
Some things to consider include:
- Regulation: Is the broker regulated, ideally by the financial authority in your area?
- Awards: Has the broker won any awards? The financial markets are very competitive, and the same goes for brokers trying to get your business. Awards can give you a good sense of who has the best platform, the best customer support, and more.
- Range of markets: What markets does the broker offer? Some brokers may only offer Forex, or cryptocurrencies, or shares. As we mentioned earlier, diversifying your portfolio is one of the keys to success in trading, and it may be easier to diversify with a broker who has a wide range of instruments on offer.
- Trading platform: Which platform does the broker offer? Is it easy to use, even if you're a beginner? Is there a lot of support available if you run into questions?
- Cost of trading: How much does it cost to trade? Remember to look at spreads, commissions and swaps.
- Customer support: How do they offer support? Is there a real person you can call, or do you need to rely on support forums?
The good news is that, if you're searching for a commodity CFD broker, you've come to the right place. Admiral Markets is an award-winning CFD and Forex broker with over 30 international awards.
We offer trading on thousands of markets, including CFDs on commodities, Forex, shares, cryptocurrencies, indices, bonds and ETFs. We also offer trading via the world's favourite trading platforms - MetaTrader 4 and MetaTrader 5. As the world's most popular trading platforms, there is a wide range of support available for both of these.
We work hard to keep our trading costs low for you, with very competitive typical spreads (2.1 pips for Silver, and 3 pips for Brent crude oil and WTI crude oil). In addition, commissions start from just $0.01 per share for shares, ETFs on shares and ETF CFDs.
Finally, we have a presence in 35 countries with support via phone, email and in local offices - in your language, when you need it.
If you're ready to get started, click the banner below to open your trading account today.
Keen to keep learning? Then check out these articles:
- What Is CFD Trading? An Introduction to Contracts for Difference
- Learn How to Trade Crude Oil CFDs
- Top Reasons Why Forex Traders Fail and Lose Money
About Admiral Markets
Admiral Markets is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.