Commodity Trading Explanation

Commodity trading refers to trading raw materials and primary resources worldwide. Generally, it involves purchasing and selling commodities like gold, oil, livestock, and similar materials to make profits. Commodity trading can sometimes entail the physical exchange of items.

However, it happens frequently through contracts and trading plans. One is futures contracts, where one agrees to purchase or sell a commodity at a specific price on a future specified date.

Key Takeaways

Commodity trading is purchasing and exchanging commodities, typically raw materials such as metals, oil, or agricultural products.
The primary aim of trading commodities is to profit by speculating on future price movements in the market.
The commodities include precious metals, energy, livestock, and agricultural products such as grains and coffee.
The prime commodity trading markets of the world are the Chicago Mercantile Exchange (CME), New York Mercantile Exchange (NYMEX), London Metal Exchange (LME), and Tokyo Commodity Exchange (TOCOM).

Commodity Trading History

Initially, traders used clay tokens as a form of contract. They would use it to represent the trade that had to take place in the near future. Even materials such as seashells and pigs were commodity money before people could think about standardized commercial contracts. Later, traders adopted silver and gold as commodity currencies. These precious metals’ value originally came from their beauty and relationship with the monarchy.

Commodity trading markets strengthened as their utility in resource allocation in Europe became evident around the late 10th century. Later, English urbanization improved infrastructure and paved the way for commercial markets. Initially, the first stock exchange market started as a commodity market.

In 1848, the formation of the Chicago Board of Trade opened a new path. After trading for over fifteen years, it listed the futures contract as the first standardized commodity trading contract. Over the next century, the market added new commodities, and investors rose with them. Since then, it is now one of the most popular trading markets.

Commodity Trading Types

Commodities are primary products and natural resources traded on the commodity markets. We can classify commodities as hard and soft commodities.

a) Hard Commodities

Non-perishable commodities are physical goods and natural resources. These are extractable resources and, thus, are susceptible to fluctuations in supply and demand. We can divide them into two types.

Metal: These include precious metals like gold, silver, diamond, and other gemstones. There are also non-precious metals like industrial metals like copper, zinc, and aluminum.
Energy: Energy commodities are resources like crude oil, natural gas, petroleum, etc. A resource like coal used for various purposes is also a famous commodity.

b) Soft Commodities

Soft commodities are agricultural products that are grown and harvested. They are perishable and sensitive to weather and other conditions; thus, they can be volatile. These types of commodities can further classify into two types.

Livestock: Futures contracts on live cattle and hogs are examples of livestock commodities. Pork and meat are also very famous examples of soft raw materials.
Agricultural: Examples of agricultural products are corn, wheat, coffee, sugar, cocoa, and rice. It also comprises vegetables like potatoes and textile materials like cotton.

What Commodities Should you Choose to Trade?

Here are some of the top commodities.

Gold: Gold’s uses include jewelry, coins, electronics, dental work, and space exploration. In commodity trading history, gold’s value has been significant because it doesn’t corrode or tarnish quickly.
Silver: Investors trade silver alongside gold. The trade for silver has been occurring for centuries. It is a beneficial commodity for stabilizing portfolios.
Oil: Oil is a valuable commodity to trade. It is sold on the world market and is one of the essential energy sources in the world.
Wheat: Wheat is an essential commodity. Wheat is a cereal grain that provides more calories per acre than other grains.

How Does Commodity Trading Work?

In commodity trading, traders exchange commodities to make money. When the traders expect the prices to rise, they open a buy position and vice versa.

Commodities exchange can happen using trading plans. Several popular investment choices exist to trade commodities.

1. Trading CFDs

Contracts for differences (CFDs) allow trading in the commodity market for a fraction of the cost. When the contract ends, both parties exchange the difference between the product’s price during the contract signing and the buy.

2. Commodity Futures

Trading futures has always been a widespread way to trade commodities. The idea is that a buyer contracts to purchase the goods in the future at a specific price. However, the contract must be closed if things do not reach the set supply until expiration.

3. Actions

Another strategy is to purchase stock in companies directly related to a commodity. Instead of buying oil directly, you might invest in the shares of an oil firm. The cost of the shares will be directly proportional to the price of the base asset. If oil prices rise, oil firms’ value will also increase.

4. ETFs for Commodities

An ETF is a pre-packaged collection of commodity stocks. In this method, trusts pool funds of small investors to build a vast portfolio. The fund can also purchase futures contracts and stock in numerous commodity firms. Commodity ETFs are inexpensive, accessible, and liquid.

Commodity Trading: How to Trade?

The procedure for commodity trading is similar to other investments, such as the Forex market. The steps to trade in commodities are as follows,

One needs to have a trading account to carry out the trades. Thus, open an account on a trustworthy platform like MCX India, Axi, Angel Broking, Zerodha, etc.
Conducting extensive research on all available trading markets is the first step. After which, one can choose a specific commodity they intend to invest in.
Analyze the data of the chosen commodity using various analytical tools. One can also employ analysts to study the market.
Money is the basis of trading. Thus deciding on its limits is necessary. Investors must always pre-plan for risks that they are capable of taking. In addition to how much money they can invest and bear losing.
Many plans like futures, options, and ETFs cater to the trader’s needs. Create and choose a trading plan for the traded commodities accordingly.
Finally, the trader opens a buy or sell position. Traders should always look at the positions they open to safeguard from losses.

Rules and Requirements to Trade in Commodities

Trading in commodities is not as easy as it may seem. There are a lot of rules and requirements that one needs to follow for the process to be successful.

The most important rule is to never trade with money you cannot afford to lose.
Trading happens on the futures market, which is open from Monday through Friday except for holidays declared by the exchange in advance. Commonly the timings differ for every country, but one can trade in commodities anytime during the trading workweek.
Commodity Futures Trading Commission (CFTC) is the head managing the regulation of commodity trading. The CFTC requires traders to have a futures commission merchant (FCM) who will trade on behalf of the trader. The FCM also requires that traders have an account with them.
One must register with the CFTC and get a license to trade in commodities.

Careers in Commodity Trading

A career in commodity trading can be lucrative but also high-risk.

For an entry-level job, one may earn $50,000-$70,000 per year, while a top-level trader may earn up to $200,000 or more. You must thoroughly know the commodities market and the variables influencing prices. One must also possess strong mathematical and analytical abilities. They must be willing to assume much risk and keep expenses low.

Career Opportunities

Commodity Specialist

They have to maintain a low-cost supply chain for the business. Thus, create economic inventories by scavenging in-budget suppliers. They handle all operations, from negotiating with the suppliers and signing deals.

Being an entry-level job in commodity trading, the salary increases with experience. A bachelor’s degree is required, and other certifications can be an asset. The average salary for the role is $73k.

Strategic Sourcing Manager

The core value of this position is to make the business cost-effective. They have to strategize their budgets to increase profits and decrease expenses. The sourcing funds are to be analyzed and put to practical use.

They require a bachelor’s degree in a relevant field and a minimum experience of four years. The average salary falls under $95k.

Commodity Trader

The traders work with their clients to fulfill their specific goals. They analyze the market, create practical trading plans, and trade in the markets on behalf of their clients. They are also responsible for providing logical advice regarding what and when to trade. However, the final decision is of the investors.

A minimum of a bachelor’s degree in a relevant field is necessary. They also need a license issued by the Financial Industry Regulatory Authority (FINRA). The average salary for this position is $80k.

Commodity Manager

The primary responsibility of managers is to supervise the operations of all departments. They must ensure to fulfill all trading requests while keeping the budget efficient. They lay down policies to make the purchasing process structured and organized.

The requirement for this role is a degree in a relevant field. It also requires an experience of a minimum of five years in the area. The average salary for this position falls under $90k.

Commodity Trading: Advantages & Disadvantages

Advantages

There is no direct correlation between all commodity markets, so it reduces the portfolio’s volatility. Suppose someone held positions in gold and livestock, and gold fell. The livestock market would not be affected.
Commodity trading safeguards the portfolio against inflation. As raw materials’ prices typically increase with inflation, commodities like gold can help stabilize funds.
Trading in commodities has always provided higher and positive returns. As prices for items are always on the rise, investors are likely to experience good returns.

Disadvantages

Variables such as natural occurrences or political events impact both supply and demand. That can drastically alter commodity prices.
When the stock market experiences a boom period, the commodity trading market typically experiences stagnation or a decline in its yields.
Sustainable livestock, agricultural, mining, and extraction practices negatively impact the environment. The oil and crude oil refining industries provide the best illustration.

Frequently Asked Questions(FAQs)

Q1. What is commodity trading? How to trade in it?

Commodity trading trades primary goods and raw materials to make profits. To trade commodities in the commodity market, one can use trading plans. Major trading plans include Physical exposure, futures contracts, underlying assets, company stakes, and ETFs.

Q2. Is it profitable to trade in commodities? Which commodity trading is the best?

Trading commodities is a high-risk, high-reward business. It can be an excellent method to protect your portfolio from a downturn or inflation. However, you should only consider it if you are well-versed in the supply and demand dynamics of the commodity market. If you’re starting, you can lower your risk by reducing your use of margin. Soybeans, wheat, gold, silver, crude oil, and natural gas are the most traded commodities in the markets.

Q3. Is commodity trading a good career? What is the salary?

A career in commodities trading can take many different forms. Some work as independent traders, while others work for investment banks or other financial institutions. Depending on the role and experience, salaries may differ. Entry-level employees may earn less than $50,000 annually; experienced employees may earn more than $200,000 annually.

Q4. What is a commodity market? When does the market open?

A commodity market is a place where resource exchange operations take place. Generally, investors can trade in commodities during the trading workweek, 24 hours a day. However, the schedule may vary in different countries.

Q5. How can I learn commodity trading? Is it suitable for beginners?

Commodity trading can be a good investment option for beginners too. Beginners can start by buying CFDs. To learn, investors can choose to opt for e-learning certification courses by MCX. Various other classes are also available on other platforms.

Q6. What is transparency in commodity trading?

Transparency in commodities trading guarantees that all stakeholders understand the management of sales. Along with that, also how government spending and development revenues affect trade.

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