The global economy runs on raw materials such as precious metals, livestock, fossil fuels, and iron ore. These raw materials are the commodities used to produce finished goods. Typically, commodities can be a natural resource of any kind consumed by individuals and industries.
Commodities offer unique opportunities for trading through their constantly changing prices. For a sophisticated investor, making good profits from commodities is easy.
If anything, commodities are an excellent opportunity for diversification, but it is not without shortcomings.
Commodities carry more risks than other investment vehicles, and you need specialized knowledge to succeed in it. So what are they all about? The following guide may come in handy for those willing to learn about trading in commodities.
Trading Commodities: What they are
Securities such as bonds and stocks are not physical goods that you can see. They exist as financial contracts. In contrast, commodities are traded in their physical form.
Commodities can be in the form of precious metals such as palladium, silver, gold, platinum, or industrial metals such as zinc, aluminum, copper, and iron ore. They can also be energy such as ethanol, natural gas, oil, or even renewables such as solar power and wind power.
Edible and non-edible agricultural goods and livestock are also trading commodities.
The prices of commodities are not constant. They depend on demand and supply forces. A change in the production of oil in the Gulf can affect global prices of oil.
The primary objective of investing in the commodity market is to profit from the supply and demand changes, and it is important to learn how to navigate the commodities market.
Commodities are a different asset class and an opportunity to reduce risk in the portfolio through diversification. They provide differentiated exposure from other investment markets and have the potential to cushion against a dismal stock market performance.
The essence of commodity trading is exchanging different physical commodity-based assets or futures contracts. Investors make bets based on the trading of futures contracts and the anticipated value of a particular commodity in the future.
For example, if the investors expect the price of grains to go up following a depressed harvest, they buy the associated futures. Investors go short or sell the futures off if they anticipate the price decline.
Commodity trading is not a new concept. It started long before the evolution of modern investment markets and can directly be linked to the rise of many empires in history.
In the US, commodity trading started with the Chicago Board of Trade in 1848. It allowed farmers to fix the prices even at certain times when the harvests are in surplus. They could use futures contracts to agree to the price of agricultural produce to cushion against price changes.
Unlike in the past, the current commodities market is well developed, and there are various commodities exchanges around the world.
A commodity exchange is a legal entity for trading in commodities and for enforcing related rules. The United States has several commodities exchanges, and they include the Chicago Mercantile Exchange (CME), Kansas City Board of Trade, Intercontinental Exchange (ICE), and New York Mercantile Exchange (NYMEX).
The list of varied commodities is now extended, and you can trade anywhere at any time.
How You Go About Trading in Commodities
There are various ways of trading commodities. Each of these has its advantages and disadvantages.
Investing in the financial markets is now easier for any level of investor, including a beginner. You can use various investment vehicles to grow your wealth, but make it your primary goal to diversify. Typically, commodities futures contracts add a bit of variety to your investment portfolio and improve your earning potential. The futures behave differently from other investment markets such as stock.
However, you should be cautious when trading in commodities. This is because they are affected by changing weather and the global supply of natural resources. Understand the commodity price charts and other important information to make informed decisions.