What is a commodities trading? What commodities are traded? What factors have the strongest influence on this financial market? All these answers you will find in our guide.
Commodities are physical goods like gold, oil or copper that are used in manufacturing processes around the world. It’s hard to underestimate their influence on people and countries. Let’s take a closer look at the commodities trading market and define the main facts that influence on it.
How commodities trading works
Commodities are rarely, if ever, physically traded. A common way to invest in commodities is through a futures contract (often referred to as futures) which is a legal agreement that allows you to sell or buy a commodity at an upon-agreed price at a certain time in the future. There are two types of commodity investors: hedgers and speculators.
Hedgers normally enter the commodity markets to diminish the risk of financial loss due to price changes. This category is represented by commercial or institutional users of commodities.
Speculators are the ones that enter the market to bet on the changing prices of commodities and other related securities.
The law of supply and demand is fundamental in commodities trading. The supply defines the total amount of a certain good, while the demand is represented by the desire or need of the consumers to pay for that specific good. If the supply is low, then the demand increases and vice versa.
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Financial products that allow you to trade commodities
Commodities stocks are stocks related to commodities. If you want to trade using this financial product, no commodity, as defined previously, will be involved – but a stock that can be influenced by a certain commodity price. For example, you can buy a stock from a gas company or a rice manufacturing company if the prices of gas and rice are expected to rise on this specific commodity.
Exchange Traded Funds, also known as ETFs, work as an instrument that trade like a stock and track the price of another instrument. Some ETFs track individual commodities, such as gold.
Mutual Funds track the underlying price of commodities and segments of the commodities markets. To gain exposure to the spot prices of the assets they invest in commodities futures and exchanges. Simply put, these funds do not invest directly in commodities, but in companies tied to certain commodities.
Types of commodities
Commodities can be divided into 4 major categories of products:
- Energy (crude oil, gasoline, natural gas);
- Metals (precious metals: silver, gold and non-precious: copper);
- Livestock and meat (pork bellies, cattle);
- Agricultural products (rice, sugar, soybeans, corn, wheat).
Fundamental analysis, chart patterns and technical indicators
There are some important trading tools (similar to forex trading tools) which can increase your chances of gaining profit while trading commodities. The idea is that “history repeats itself” and if you manage to understand the commodities market’s dynamic and read its patterns, your chances of getting the best results will increase significantly.
The fundamental analysis is a method of evaluating commodities (or other securities) to measure their value, by analyzing all related economic, financial and other factors which can influence that value. The goal is to gain profit from understanding the supply/demand and the future price movements on commodities markets.
The chart patterns can also be extremely useful as they have a high probability of success but are not guaranteed to work any time. There are two types of patterns that appear on charts: reversal and continuation patterns.
Reversal patterns show when a very important reversal in trends is taking place. Some of the most common reversal patterns for trading CFDs are:
- Double tops and bottoms;
- The head and shoulders bottoms and tops;
- Rounding bottoms and tops;
- Tripe tops and bottoms;
- Spike bottoms and tops;
- Key reversals;
- Island reversals.
Continuation patterns form after price trends up or down. They indicate the trend out of which the pattern forms will continue after the pattern has completed. Some of the most common continuation patterns are the Bull Flag, the Bear Flag and the Continuation Triangle pattern.
Technical indicators are mathematical formulas that involve price and volume and they show you where a commodity is trending. One of the most common technical indicators is the Moving Averages (MA) which indicates the average price over a certain period for a commodity or other security. Other popular technical indicators are: Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI) and the Stochastic indicator.
Commodity trading – a hedge against inflation
Inflation is caused by the devaluation of currencies and it results in a long-term rise of the prices for consumer goods and services. Because commodities are and always will be in demand, trading them can act as a hedge against inflation. Simply put, due to their organic value, they remain immune to inflation while other securities like stocks can suffer under the pressure of global inflation.