Trading commodities involves buying and selling products that either are extracted out of the ground (platinum, silver, gold, crude oil) or are derived from products that are extracted out of the ground (natural gas).
Also included in the definition is trading agricultural products that have economic values (coffee, wheat, corn) or derivatives from these products (sugar). Commodity trading operates on the same principle that trading stocks, currencies and other financial instruments do. That is, it is based on the day to day change in the commodity’s perceived value. The change in the value is based on the changing perception of value that market speculators, traders, dealers and farmers hold. It is how market participants perceive the commodity’s value that determines what the demand is for the commodity and its price as well.
How Commodity Trading Works
Commodities are traded on the basis of spot and futures.
In an on the spot commodities market, buying and selling of commodities takes place without the commodity being physically exchanged. Traders are able to purchase or sell commodities and make profits based on the on the spot commodity platform price differences. Many forex brokers these days are adding commodity instruments into their portfolio of assets, which makes trading spot contracts on commodity instruments easier to do now.
Trading commodity futures involves trading options contracts that may or may not involve physically exchanging the commodity itself. Actually, commodity futures are in the same form that commodity contracts got traded in many centuries ago. The idea behind futures trading in the past was standardizing the quality, quantity and exchange prices of commodities, given that most of them (particularly agricultural commodities) were subject to many uncertainties and were perishable as well. A farmer wanting to ensure that he could get a certain price when selling his products in the market would make a contract with a dealer in order to receive a specific payment price in exchange for a specific quantity of his product (commodity). This was done to hedge against potential price fluctuations. The dealer wanted to ensure that he would receive a specific standard and quantity of the commodity without worrying about having to pay an excessive price in the event of a natural disaster or inflation. So therefore, he was willing to come to an agreement with a farmer which was basically a commodity futures contract. The futures contract basically benefited both parties.
Commodities can be traded on the American Exchange (AMEX), as Exchange Traded Funds (ETF) and on the binary options market as well.
Commodity trading takes place oat the Chicago Board of Trade, the New York Mercantile Exchange (for crude oil) and on the ICE (for energy futures like natural gas futures).
Just as in forex trading, the responsibility of the commodity broker is matching buyers with sellers of a commodity. Brokers match all of the buy and seller orders.
The liquidity requirements for commodity trading are a lot higher than they are for forex trading. Therefore, in order to trade commodities a trader will need to have more capital. Forex brokers who are providing commodities within their underlying assets are offering traders much smaller contracts. Commodities market price movements are around 0.25 to 0.5 pips for every tick. It depends on whether it is a mini contract or full contract. Brokers do provide traders with leverage for larger sized contracts.
Trading Commodity Procedures
The first step is contacting a broker and setting up a commodities trading account. The trader will fill out a form online to open an account, submit proof of identity (international passport or national ID card) and proof of address (bank account statement or utility bill). After the account is activated the trader will fund the account. These days many forex brokers are offering trading in crude oil, silver and gold, since these are the commodities that are most traded. Other brokers such as Interactive Brokers offer both mini and full contracts as priced on the commodities exchanges.
Trades can be conducted by traders using a virtual platform or through their brokers you use the open outcry system on Chicago’s commodities exchange floor. Traders can trade commodity futures options through options brokers as well. Trading commodity swaps is another opportunity that is available. There is always something for everybody to trade with commodities trading. Beginners can start out with commodity binary options. Traders with more experience can trade futures and options contracts.