The commodities market is the oldest market in the world. This commodities trading guide is designed for the new trader and the seasoned expert alike. You will find plenty of practical steps for trading commodities online.
Since time immemorial, commodities trading has dominated the scene. The sheer volume of commodities that are traded on a day-to-day basis is beyond comprehension. From the oceans to the continents, traders have transported commodities to every conceivable corner of the planet where people live.
Fortunately, you don’t have to sail the seven seas to become a commodities trader nowadays. In just a few clicks, you can participate in this burgeoning global market from the comforts of home, or on the go right here at AvaTrade Australia.
Modern-day commodities markets are festooned with plenty of financial derivatives. There is no need to physically buy and sell the underlying financial instruments; you can simply trade commodities CFD contracts at your leisure.
The inherent value of diversification is evident in the increasing number of commodities being added to portfolios around the world. A growing number of traders now actively engages in commodities trading, for a variety of reasons. Growth prospects, hedging against inflationary pressures, ROI from high volatility, and diversification are some of the many reasons why commodities are a hot ticket item.
Table of Contents
- What is a commodity?
- How does commodity trading take place?
- How are financial derivatives used in commodities trading?
- How to trade commodities at AvaTrade Australia?
- Commodities trading advice before getting started
- Sage Trading Advice Before Getting Started
Commodities trading explained
What is a Commodity?
Commodities represent goods that are exchanged to satisfy needs. These can be hard commodities that are mined, and soft commodities that are farmed. There are qualitative differences between commodities, but they are insignificant in the broader scheme of things.
Since commodities are interchangeable to satisfy needs, or for providing services, they are known as fungible goods. The name is a derivation from the French word commodities, meaning convenience or advantage. It’s easy to make sense of the actual definition if you practically apply commodities to day-to-day living.
For example: if you are hungry, you have a need for nutrition. The commodities that you consume to satisfy that need – milk, eggs, poultry, fish, beef, et cetera – will satisfy that need for nutrition. Since many different foods can provide nutrition, commodities are by their very nature fungible. They can be exchanged for one another to satisfy the need.
It is precisely this line of thinking that dominates in the commodities trading arena. Supply and demand considerations, and raw material prices factor into the equation when consumers seek commodities to satisfy needs. You will often find one commodity being replaced with another which performs a similar function, to satisfy needs. In economic terms, this is known as elasticity. It is central to understanding how demand for raw materials operates in the financial markets.
In recent years, there has been a strong push towards petrol substitutes in the market. From a purely economic perspective, increasing demand and dwindling supply is leading to a situation where prices become untenable. Over the short-term, people may deal with rising prices, but moves are afoot to find substitutes.
There are social and environmental issues driving the push towards petrol substitutes too, notably greenhouse gas emissions, and destruction of the natural environment. As it stands, major car manufacturers have embraced the winds of change, and are investing a fortune in hybrid vehicle technology, ethanol-powered vehicles, and self-driving technology too.
The motor vehicle industry and the energy industry are intertwined, and this relationship exists for the majority of commodities. With this understanding of commodities, we can now shift our attention to the 2 macroeconomic categories of commodities, namely hard commodities and soft commodities.
Hard commodities are hard by their very nature. They are either mined, or natural resources. They include the following:
- Precious Metals such as silver, gold, platinum
- Industrial Metals such as iron, steel, aluminium, copper, zinc, nickel
- Energy Commodities such as Brent crude oil, WTI crude oil, natural gas
Soft commodities are alive, or grown. They include livestock and agricultural produce. They can be divided up accordingly:
- Livestock and Animal Derivatives such as eggs, milk, meat, poultry, and cattle
- Agricultural Produce such as fruit and vegetables, coffee, cocoa, vegetable oil, soy, cereal, wheat, corn, sugar and the like.
How Does Commodity Trading Take Place?
At first thought, you may assume that commodity trading requires you to clear out your basement, or your living room to make space for countless barrels of crude oil, gold bullion, or natural gas. Forget that. With commodities trading, you don’t need to stockpile any physical commodities whatsoever. Today, commodities trading largely takes place in the form of derivatives products.
These financial derivatives such as CFDs (Contracts for Difference) are derived from the underlying price of the commodities themselves. Buy low and sell high – that’s definitely one avenue available to commodities traders today. Of course, it’s entirely possible to short commodities by hedging against price appreciation.
Several financial derivatives are available for trading commodities today. Notable among them are ETCs (Exchange Traded Commodities) and CFDs (Contracts for Difference). Other options include futures markets, and spots.
You may well have heard about options trading for commodities. This is an incredibly important commodities trading resource, and we have dedicated plenty of space to it in our options trading article.
How are Financial Derivatives Used in Commodities Trading?
AvaTrade Australia provides an abundance of material about futures and CFDs. In this commodity trading guide, we will limit our discussion to how futures and CFDs can be used with commodities trading. For further insights and understanding, we encourage you to take a look at our article on CFDs and futures.
Spot & Futures
Spot contracts, or rolling daily contracts are dependent upon the daily price movements of the asset at the time the contract was initiated.
These intraday contracts are best suited to short-term trading, since they expire at the end of the trading day. They must be extended on a day-by-day basis via a technical operation known as a rollover. Of course, the trader can simply close them earlier and they won’t roll over. Take a look at the expiration dates of similar contracts for trading purposes, and the associated rollover dates.
Let’s shift our attention to futures. These types of contracts are much more useful to retail traders and investors.
A futures contract is a forward contract. It involves an agreement between counterparties to exchange an asset – commodity – at a specific price, and an agreed upon date.
With futures contracts, the timeline can range from several days to several weeks, even to several months. It all depends on the underlying asset in question.
At this juncture, you may be wondering why futures contracts have such relevance in the financial markets? For starters, producers need to protect their investments from price fluctuations over time. This ability to lock in a price ahead of time helps to stabilise markets for producers and consumers too.
With futures contracts, the contract can easily be exchanged for the physical asset and for cash. This generates 2 unique strategies – hedging for speculation.
A simple example will help to highlight how this works in practical terms. Let’s assume that a farmer prepares his land by investing a sizeable amount in cultivating the land for wheat, barley, maize, or sorghum production. Clearly, the farmer is uncertain how much he will be able to grow on the land during the season. He also doesn’t know what the price will be once the produce is ready for market. To mitigate all the risks, the farmer opens a futures contract. This gives him the right to sell his product at a fixed price, on a specific date. This is how he covers his initial investment.
With speculators, it’s a different story. They’re not interested in buying or selling the actual commodity. They buy futures contracts to resell them at higher prices. The objective is to profit from price forecasts based on market trends.
A Contract for Difference (CFD) is a financial derivative product which allows traders and investors to benefit from price movements of the underlying assets – commodities in this case – without actually physically possessing the commodities. In other words, you are trading contracts which mirror the price movements of the financial instrument.
When you buy CFDs, you don’t buy the wheat, barley, sorghum, maize, livestock, crude oil, petroleum, or metals – you simply buy the contract. You have the right to receive compensation based on your assessment of price movements in the future. If you are correct, you will realise a favourable return. If not, it’s back to the drawing board. Let’s take a look at the advantages of trading commodity CFDs at AvaTrade Australia:
Benefits of Trading Commodity CFDs:
- No physical commodities purchased – this means that there are no accident commissions, no storage costs, no transportation of goods and merchandise, no maintenance to worry about.
- Financial leverage is used – by applying leverage, you can magnify the trading power of your capital by a significant amount, thereby benefiting from your commodities trading activity.
- Quick and easy execution of trades – commodity CFD trading is designed with simplicity and speed of execution in mind. You can open and close multiple trades within the same day.
- Go long or short with commodity CFDs – unlike linear investments which require asset appreciation, you can benefit from rising or falling markets.
- Hedging options – since commodities can be inversely correlated, you can take out opposing positions on different commodities to cover yourself.
- Multiple assets to choose from – with commodities, you have carte blanche to pick your preferred assets.
Now that we have extolled the virtues of commodity CFD trading, a caveat is required. CFD trading is inherently volatile, risky, and subject to loss. If you trade commodity CFDs without conducting the necessary research, analysis, and due diligence, you can lose everything. We strongly encourage you to study our article on CFDs. This will certainly help you to make better trading decisions.
ETC (Exchange Traded Commodities)
ETCs function similarly to ETFs, but unlike ETFs they are specific to commodities trading. ETCs are essentially financial instruments that are traded on the stock exchange. They mimic the returns of the underlying commodity, or the index which they are associated with.
Remember that ETCs are passively managed trading tools. For more information on how they function, it is strongly recommended that you take a look at the article on what an ETF is. An ETC is similar in many respects to an ETF, with underlying differences, notably:
- ETCs allow for investments in indices and individual commodities.
- ETC returns depend upon the spot price and the future price of a specific commodity, or a basket of commodities.
- There are low capital requirements for ETCs, and they are strongly correlated with their underlying financial instrument.
Commodity Trading at AvaTrade Australia
Commodities are indeed a viable means of diversifying your financial portfolio. They have also proven to be an effective way of generating income, and for hedging purposes too. Plus, there is a certain allure to commodities trading. Since this type of option is strictly correlated with the good in question, it is an interesting trading prospect.
AvaTrade Australia brings the world of commodities trading direct to your screen, on PC, Mac, and mobile devices. You will have every opportunity to trade a wide range of popular commodities wherever you are, and whenever markets are operational. Getting started is a breeze, simply open a trading account, mate. You are welcome to open a new trading account with us, or if you’re already registered, simply trade your favourite assets with us.
It’s always a good idea to try out different tactics and strategies on our demo trading account, before you trade for real money. Once you’re confident about your trading prowess, you can switch over to a real-money trading account. Here at AvaTrade Australia, you’re free to take advantage of our commodity trading benefits:
- Our broker is fully regulated
- Choose from a wide range of commodities from one trading account
- We offer multilingual customer support to clients 24/5 for added convenience
- Pick from any of our powerful trading platforms including AvaTradeGO Mobile, MetaTrader5, or MetaTrader4
- AvaTrade Australia offers competitive spreads and advantageous trading conditions
AvaTrade is a globally-recognized brand with operations and activities in multiple countries. We are licensed, regulated and overseen by scores of oversight bodies, in Europe, South Africa, Australia and beyond.
Our commitment to trading excellence has been duly noted by the world’s leading authorities, and oversight bodies, culminating in multiple worldwide trading awards over the years.
Sage Trading Advice Before Getting Started
Commodities trading is certainly exciting, and potentially rewarding. These simple tips will help you to get the most out of your trading sessions:
- Put in the time required to benefit from commodities trading – make a point of reading as much as possible about the demand & supply factors, macroeconomic variables, and trends related to commodities trading.
- Carefully select a broker that checks all the boxes – brokers vary in terms of quality, offerings, credibility, and resources. Choose carefully.
- Budget for your trading sessions – it’s important to establish a trading budget to mitigate against downside risk. Never risk more than you can afford to lose, and never chase your losses.
- Put a trading plan into effect – strategies will protect you in the event of untoward market movements.
- Keep striving for better – the more you read about the financial markets, the better you will become at trading. Increase your knowledge as much as possible to broaden your horizons.
FAQs Commodities Trading
Why should I trade commodity CFDs?
Futures contracts are the traditional way that commodities are traded. But this isn’t necessarily the best way to trade commodities. A large number of traders don’t have access to futures, owing to the substantial upfront investment requirements. Leverage also plays a part in futures markets. Sometimes, trades can move in your favour and sometimes they can go against you. When you add leverage to the equation, you can amplify profits and losses. When you trade commodity CFDs, you can mitigate against this. There are no liquidity issues with CFD trading. You can begin trading with a couple of hundred Aussie dollars, and decide whether or not you wish to use leverage in your trades.
What commodities should I trade?
Everyone has a unique preference for trading commodities. There is no blanket answer to the question. Your point of departure should be the commodities that you understand best, and the commodities that you are partial to. In terms of popularity, gold and crude oil are top selections. Both of them have excellent liquidity and there is plenty of data on them in the financial markets. Stick with what you know best, with what you feel comfortable trading. Provided you are willing to put in the time, you will definitely be able to trade commodities online.
Where can I trade commodities?
Commodities can be traded online, right here at AvaTrade Australia. It’s not necessary to trade them in person. Simply register a trading account with us, and you’ll be trading commodity CFDs in short order. Use our demo trading account to get started, and once you’re comfortable you can trade for real money online.