How To Trade Commodities: A Step-By-Step guide

Introduction

In the world of trade, commodities are essential raw materials that can be bought, sold, or traded. These assets are the beating heart of global trade and are valued on the basis of their innate quality rather than the name of the brand or degree of product enhancement. Commodities are exchanged in physical form or as financial assets in the commodity market and are the backbone of many world economies. Therefore, these types of assets are very popular among investors as they offer unique trading opportunities and a range of applicable strategies.

The commodity market offers several primary but diverse categories that include energy resources (like oil, natural gas, and coal), metals (such as gold, silver, and copper), and agriculture products (such as wheat, corn, and coffee). Each category is of the utmost importance in maintaining the smooth operation of the world economy as it affects almost every industrially manufactured product. For example, oil prices affect transportation and manufacturing costs around the world. 

There are many reasons why investors trade commodities, but one of the most important reasons is that trading commodities offers investors the opportunity to diversify their portfolios beyond traditional assets. Another important reason is that commodity prices are influenced by different factors such as geopolitical events, natural disasters, and seasonal patterns, which allows the investors to play their hand accordingly and make a profit even when the rest of the market is uncertain. Generally, the process of trading commodities involves buying and selling contracts, where traders or investors speculate the direction of a commodity’s price over a specified period of time. However, in order to speculate, a deep knowledge of the commodity market is crucial.

What Are Commodities?

Simply put, commodities are the basic building blocks of more complex products. Based on quality, each commodity can be classified into one of two categories: hard or soft. Naturally occurring resources that are extracted or mined, like gold, oil, or silver, are known as hard commodities. In contrast, agricultural products or livestock like wheat, sugar, and cattle are called soft commodities. Economic factors that reflect these two categories influence the supply and demand of each commodity. For example, a hard commodity is often influenced by extraction costs, changes in technology, and geopolitical stability, while growing seasons, weather patterns and climate change affect soft commodities. 

Each commodity is integral to the world economy and plays a role in industrial production, transportation, energy, or the food supply chain. As they are the building blocks of nearly every industry on the planet, any fluctuation in their production and, consequently, their prices can have a widespread effect on the world’s inflation rates, currencies, and economic policies. For example, a poor coffee harvest can increase the price of coffee beans globally. It is important for traders to understand the dynamics closely as different factors influence the price of a commodity. These prices are forever volatile, making commodity trading very attractive in speculative trading. 

How Are Commodities Traded?

There are several primary methods that are used to trade commodities. Each method has a distinct approach, varying risk levels, and flexibility for the user. Following is a list and details of a few of these methods:

Future Contracts

These contracts are standardised agreements to buy or sell a specific quantity of a commodity at a predetermined price on a future date. This method is most commonly used for commodities like oil, gold, and agricultural products. A trader needs a brokerage account on a platform that allows futures exchange to start trading future contracts. One important thing to remember here is that futures trading allows for leverage, which offers investors a chance to control larger positions with relatively small margins however, this also means that there is an increase in the overall risk. Future contracts are, therefore, a popular choice for traders who have years of experience in the field and can skillfully manage the volatility and complexity of this market.

Options on Commodities

Options on commodities are flexible options for traders. They give them the option to buy or sell a commodity at a set price before a specific expiration date. This allows the traders to manage risk by choosing not to exercise the option if market conditions are unfavourable. A trader needs a brokerage account on a platform that allows trading options on commodities. These options are a great way to reduce risk for traders compared to future contracts. They still offer great profit-making potential, making this method a good fit for traders looking to speculate or hedge more strategically.

Spot Market

The spot market, also known as the cash market, involves buying and selling commodities for immediate delivery at current market prices. This method is very popular among companies that require physical delivery of the commodity, such as a manufacturer purchasing gold to make jewellery. Spot markets work on direct transactions rather than exchanges and are less popular among day traders due to logistical constraints. 

Exchange-Traded Commodities (ETCs)

ETCs are very similar to exchange-traded funds (ETFs) but focus primarily on commodities. They allow traders to gain exposure to commodity markets without actually entering them. Most platforms offer ETCs, which makes them accessible and straightforward. To start trading ETCs, a trader needs a brokerage account on a platform that supports stock trading. ETCs are a great way to diversify your portfolio with lower risk and less complexity than other commodity trading methods. 

Step-by-Step Guide to Trading Commodities

The traders must hold a valid brokerage account on a suitable platform to trade commodities. Here we explain a step-by-step guide to trading commodities:

Step 1: Set Up Trading Account

The first step is to set up a trading account. Many great platforms are in the market today, but each has something unique. Each platform has its own associated fees, commissions, features, and security regulations. Do thorough research before settling on a platform. After selecting a brokerage platform, set up your account and make sure to provide accurate personal information. Once the platform has everything it needs, you will get an email of your account confirmation and activation. 

Step 2: Learn to Use the Software/Platform and Tools 

Before jumping into trading, learning how to use the platform and its tools is best. This will not only help you have a smooth trading experience but also help you make logical and profitable decisions. Familiarise yourself with the platform’s interface and features like charting tools, technical indicators, and market data feeds. Most platforms also offer demo accounts where you can simulate trading without using and risking real money. 

Step 3: Choose the Commodities for the Trade

After thorough research, select a commodity that aligns with your training goals, interests, and risk tolerance. The most commonly traded commodities are gold, oil, and natural gas, but many more are available. Try to understand the driving factors behind these markets and the factors that influence the prices. Rather than research a handful of commodities at the start, pick a few of them and keep your research focused. This will help you in making an informed choice. 

Step 4: Develop a Trading Plan

A trading plan is one of the most important trade steps. Start by outlining your goals for the trade and your risk tolerance, and think about your preferred trading style. Your trading plan and style will be refined over time, but it is important to learn from your mistakes and continue learning and researching. Focus on your strengths and develop a well-defined strategy that will help you stay disciplined. 

Step 5: Execute Your First Trade

Once you feel comfortable with your knowledge, the selected commodity, and the platform, execute your first trade. Make sure to deploy risk mitigation strategies to minimise loss and monitor your trade closely. Use stop-loss orders, position sizing, and portfolio diversification to avoid mishaps. 

Platforms and Tools for Trading Commodities

There are a ton of trading platforms that offer breakout trading and the necessary tools and indicators to execute such trades. Here are some of the most popular platforms and tools for trading commodities:

MetaTrader

MetaTrader is probably the most famous trading platform among traders because of its robust capabilities and tools. The platform offers the integration of custom indicators to assess the markets and monitor price movements, detailed reporting tools, and unmatched automation for efficient execution.  

PU Prime

PU Prime is a globally recognised platform offering competitive trading conditions and access to a broad range of commodity markets, including CFDs on crude oil, gold, silver, and agricultural products. The platform is designed to cater to traders of all experience levels, with a user-friendly interface and advanced trading tools such as Autochartist for market analysis, real-time data feeds, and robust risk management features.

PU Prime also provides comprehensive educational resources, daily market insights, and multilingual customer support, ensuring traders are equipped with the knowledge and tools to navigate the complexities of the commodity market effectively. Whether you’re a beginner or an experienced trader, PU Prime offers a secure and dynamic trading environment to diversify and enhance your portfolio.

TradingView

TradingView is a popular and intuitive platform offering powerful charting capabilities. One thing to clarify here is that this platform does not facilitate trading but only offers valuable tools and analysis for planning all sorts of trades. This platform offers built-in, community-created, and experienced correlation indicators that can be used to assess trades. Users can create custom indicators and visualise their spreads to identify entry and exit points. Overall, TradingView is a decent platform to visualise your trades. 

Tools for Commodity Trading

Charting tools, trading alerts, technical indicators, and economic calendars are the most important tools for commodity trading. Charting tools are essential for analysing market trends and making informed decisions based on the trends. Trading alerts are important to stay on top of changing price levels or market movements. Indicators like the Relative Strength Index and Bollinger Bands provide insights into market momentum and potential reversal points. Lastly, an economic calendar is important to anticipate the impact of economic events on commodities. 

Understanding Commodity Market Risks

Commodity markets offer substantial opportunities for making a profit but also risks that can affect individual traders and broader portfolios. Understanding these risks is important for anyone entering the commodity market.

Price Volatility 

MetaTrader is probably the most famous trading platform among traders because of its robust capabilities and tools. The platform offers the integration of custom indicators to assess the markets and monitor price movements, detailed reporting tools, and unmatched automation for efficient execution.  

Geopolitical Risks

Most of these commodities are sourced from regions with ongoing conflicts or political instability. Tensions and sanctions in these regions can affect trade agreements and have a lasting impact on the global trade markets that trade in these commodities. 

Weather and Natural Disasters

Soft commodities are highly dependent on optimal weather conditions. Therefore, changing weather and natural disasters can threaten these commodities and bring unpredictable changes in the market. 

Demand Shifts

The demand for commodities often fluctuates with the health of the economy. During periods of economic growth, the demand for hard commodities typically increases, whereas in a recession, it can reach a dramatic low. Likewise, the demand for soft commodities may also fluctuate based on the weather. 

Largest Traded Commodities in the World

A few of the largest traded commodities in the world dominate the global markets due to their demand, economic significance, and role in various industries. Here are a few of the largest traded commodities in the world today:

Crude Oil

Crude oil is a natural fossil fuel which is refined into different products like diesel, gasoline, and jet fuel for daily use. It is one of the most traded commodities and is responsible for powering industries, transportation, and electricity generation around the world. It is also the world’s primary source of energy, which is why it influences manufacturing expenses, transportation costs, and consumer goods prices. Geopolitical tensions, production quotas, and supply chain disruptions influence the price of crude oil. A fluctuating crude oil price can have a ripple effect across the global economy. The main reason behind crude oil’s popularity in the commodity market is its consistent demand and global importance, and it is highly unlikely that the demand will fade anytime soon. 

Gold

Gold is a precious metal used for jewellery, electronics, and as a financial asset in homes and banks. Countries and humans see gold as a safe haven asset, especially during economic uncertainty. Therefore, it plays a significant role as a hedge against inflation and currency fluctuations. Investors turn to gold in seasons of economic downturns, which can drive its price upward. As the central bank holds significant reserves in gold, it appeals to investors as a store of wealth. Gold is seen to have a relatively stable demand and resistance to depreciation, which makes it a cornerstone of commodity trading. 

Natural Gas

Natural gas is a fossil fuel used for electricity generation, heating, and industrial fuel. Its role in energy production has grown with the Industrial Revolution. The prices of natural gas can significantly impact heating and energy costs for households and industries all around the world. However, the supply and demand of natural gas are influenced by geopolitical factors and seasonal weather. Also, with the growing demand for cleaner energy alternatives and reduction in carbon emissions, natural gas only attracts traders who are looking to capitalise on its long-term growth potential. 

Coffee

Coffee is probably the most popular beverage globally. It is cultivated in tropical regions and is a stable commodity in international trade. Brazil and Vietnam are the leading producers of quality coffee beans. The coffee industry supports the economies of quite a few countries and creates significant employment opportunities. The cultivation of coffee and, consequently, its price are influenced by weather patterns, harvest conditions, and currency fluctuations. 

Investing in Commodities vs. Stock Market

Investing in stock markets and commodity markets are fundamentally two different approaches, but they are popular all the same. Each approach offers unique benefits and risks that an investor must be knowledgeable about. Here, we compare these approaches.

Volatility 

Commodity prices are naturally highly volatile, as factors like weather, geopolitical events, and supply-demand imbalances influence them. In contrast, stock prices are also subjected to volatility but are influenced by company performance, economic conditions, and investor sentiment. The stock market is relatively more stable and offers long-term growth compared to the commodities market.

Risk  

Trading in commodity markets involves a high level of risk because of unpredictable price swings. Factors such as extreme weather, global supply disruptions, or sudden political tensions can lead to rapid price changes. Stock markets are generally linked to company performance, industry trends, and broader economic conditions, reducing the overall associated risk compared to commodity trading risk.

Return

Commodities offer lucrative returns in the short term, especially during periods of economic turmoil or inflation. However, they may lack consistent long-term growth, as prices tend to fluctuate within ranges. On the other hand, stick markets are more steady and offer long-term growth potential. However, stocks are also vulnerable to market downturns. 

Ultimately, both commodities and stocks trading and investing offer volatility, risk, and return but also significant profit-making opportunities. 

Buying and Selling Commodities

Buying commodities and selling commodities in the market involves a strategic process that varies depending on the type of asset, trading method, and strategy used. Here are the basic steps for buying and selling commodities:

Good Commodity Stocks to Consider

Companies in the mining, energy, and agricultural industries are often tied to commodity price movements, making them an attractive avenue to pursue. Here are some of the top companies in the commodity sector that are worth considering for your next trade:

Mining

1. Barrick Gold Corporation

Barrick Gold is one of the world’s largest gold mining companies, with operations spanning North and South America, Africa, and Australia. It’s an attractive option for investors seeking stability and exposure to precious metals.

2. Rio Tinto Group

Rio Tinto is a diversified mining giant with interests in iron ore, copper, aluminium, and other key resources. It is known for its significant role in iron ore production and profits from global industrial demand.

Energy 

1. ExxonMobil Corporation

ExxonMobil is one of the world’s largest publicly traded oil and gas companies, with extensive exploration, production, and refining operations. The company plans to expand its renewable energy footprint, making it a long-term investment option in the energy sector.

2. Chevron Corporation

Chevron is another global energy giant that operates oil, gas, and renewable energy. Its focus on clean energy projects adds a layer of sustainability to its traditional oil and gas business.

Agriculture Firms

1. Archer Daniels Midland Company 

ADM is a global leader in agricultural processing and the production of food, animal feed, and biofuel products. Because of its diverse grain, oilseed, and corn processing portfolio, the corporation is immune to fluctuations in the cost of particular crops.

2. Bunge Limited 

Bunge is a global agribusiness and food company that produces and sells grains, oilseeds, and other agricultural commodities. With an increased focus on sustainable agriculture, Bunge is positioned to benefit from global food security efforts.

Commodity Trading Summary

Trading commodities offers a unique opportunity for diversification, hedging, and potentially benefiting from global economic trends. So far, we have covered the essential steps to start trading commodities effectively. Each step explained is crucial to building a strong foundation in the ever-robust commodity market. There are a number of potential benefits and risks associated with trading commodities. However, understanding the influences on commodity prices can significantly affect trading success. 

Seeking professional advice can help beginners learn to trade commodities and make informed, well-researched decisions that will help them refine their strategies. With the right approach, continued commitment to research, and consistent risk management, trading commodities can be a fruitful addition to the investment portfolio.