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How to Start Commodity Trading: A Beginners Guide

Nowadays, commodity trading is no longer available only to farmers, manufacturers, and governments. Any individual trader with an internet connection can speculate on the price movements of commodities via futures contracts or CFDs. 

However, although the process of getting access to the commodity market is fairly simple, you still must understand all the fundamental aspects of these commodity instruments – how they work, what to follow, what are the basics of commodity trading, and what are the most traded commodities out there. 

What Exactly is Commodity Trading?

When you buy different products at a grocery store, you most likely do not contemplate how these materials reach your local store. Normally, the process starts at a commodity exchange where various commodities are traded and sold to retailers. And, these commodities are basically raw materials that can be traded on the commodities markets like any other financial instrument. 

Historically, the first commodity futures exchange dates back to 1730 when two sides exchanged rice futures. Then, in 1864, the first futures trade was listed on the Chicago Board of Trade (CBOT) when two parties exchanged grains futures. Since then, future contracts have become an integral part of global trade and a popular way for traders to speculate on commodity prices. 

What is the Purpose of Commodity Futures Contracts?

The purpose of commodity futures contracts is to protect farmers and grocery retailers from unexpected price fluctuations. For instance, with a futures contract, a farmer can assure a certain price at which the crop will be sold and vice versa. Additionally, futures exchanges also create big global marketplaces where buyers and sellers can send and receive commodities. In fact, some commodities futures contracts are deliverable, which means you must collect your cargo from the port at which it is registered on the contract. If you do not do that, you must pay very high fees for the port for each day the cargo stays there. 

But for the individual trader, commodity trading works pretty much the same way as trading on any other market. It involves the buying and selling of a wide range of derivative instruments to predict the future prices of commodities and make speculative decisions.

FYI

As of 2021, there are 121 future exchanges in the world. Since 2019, the National Stock Exchange of India (NSE) is the largest futures exchange in the world, followed by the Chicago Mercantile Exchange (CME).

Commodity Trading  – Futures vs CFDs

Nowadays, as the markets have significantly evolved, there’s typically more than one way to trade a certain market. So, much like other markets, commodities can be traded in three ways – trading physical commodities, trading futures contracts via an exchange, or trading CFDs via online brokers. As we assume you are not planning to physically buy cargos of crude oil or corn, that leaves us with two options – Future contracts and Contract for Difference (CFDs). 

In the commodity markets, CFDs and futures offer traders very similar products, which makes a bit of confusion for traders on what form of contract is better for them to use. Generally, both CFDs and futures are derivative products that replicate the price of the underlying commodity asset and can be traded with leverage and other benefits. Still, there are notable differences between the two and each type of trading is more suited for different types of traders. 

Liquidity 

The primary distinction between commodity futures and CFDs is in liquidity. Futures trade on the exchange where many participants including farmers, producers, hedge funds, and speculators buy and sell commodity futures and create liquidity in a certain market. However, very often when you trade futures (especially futures with distant expiration dates), you’ll find yourself in a liquidity trap where there are no buyers or sellers. 

CFDs are traded directly with brokers that ensure you get an execution at any given moment. Consequently, you won’t have any issues getting in and out of positions. 

Best to Trade With – CFDs

Range of Commodities

Although CFD brokers have been widening their selection of products in recent years, it is not yet possible to get access to the full range of commodity products. Normally with a CFD broker, you get access to 10-20 commodities. 

When trading futures contracts via the exchange, you actually get access to all futures contracts traded on the exchange.  In that aspect, many traders take advantage of futures spreads on the same asset – meaning buying one contract with a certain expiration month and selling the other with a different expiration month. It is a great trading strategy that enables traders to lower the risk and essentially trade the spread between two different contracts (this strategy is especially effective with seasonal commodities such as grains, energy, etc). 

Best to Trade With – Futures

Initial Deposit Required to Start Trading 

Futures are physical and deliverable financial contracts, and usually, the size of the contract does not enable small investors to trade it. In most cases, futures brokers require investors to deposit somewhere between $5000 to $10,000 in order to be able to open a trading account. There are also high margin requirements due to the complexity of futures contracts. 

Still, trading commodities via an exchange comes with some benefits. Future exchanges need liquidity to provide a functional market, and as a result, active traders that trade higher volumes are compensated with monthly rebates and generally pay low fees. 

On the flip side, CFDs are more flexible simply because these contracts are sort of a derivative of a derivative. For this reason, opening a CFD trading account does not require a high initial deposit and most brokers offer to start with a few hundred dollars. Also, there are no fixed fees nor exchange fees. Instead, you pay the spread and an overnight fee. 

The bottom line is that it depends on the budget you have and the type of trader you are. 

Best to Trade With – CFDs/Futures

Account Creation Process

Another thing to consider is the account creation process. In this aspect, it is important to understand that a futures contract is an agreement between the buyer and seller to deliver a commodity (physical or cash settlement) at a certain date, location, and price. Therefore, when you open a futures contract account, you’ll have to go through a fairly long process of delivering your details, bank accounts, verifying your identity, and providing your purpose of trading futures. 

To trade CFDs, you’ll need to sign up, open an account with your chosen CFD broker and meet the minimum deposit requirement provided by the CFD broker. The process is much easier when compared to opening an account with futures contract brokers and can usually be completed in 1-3 days.  

Types of Commodities

Commodities are categorized into four types of categories. These can be classified as hard and soft commodities with the difference between the two is that soft commodities are grown or produced and hard commodities refer to any commodity that must be mined or extracted. With that in mind, here are the four types of commodities:

  • Metal Commodities (Hard) – These include gold, silver, copper, aluminum, platinum, palladium, Zinc, and Tin. 
  • Energy Commodities (Hard) – Includes WTI crude, Brent crude oil, natural gas, gasoline, heating oil, kerosene, ethanol, and coal. 
  • Livestock and Meat Commodities (Soft) – Includes live cattle, lean hog, feeder cattle, port cutout, and milk. 
  • Agriculture Commodities (Soft) – Includes wheat, corn, soybean, soybean oil, soybean meal, rice, cocoa, coffee, sugar, cotton, orange juice, wool, lumber, oats, and canola. 

FYI

The most popular commodity index funds include the S&P Goldman Sachs Commodity Index (S&P GSCI) and the Commodity Research Bureau (CRB) Index Index.

What Are the Most Traded Commodities in Financial Markets?

Commodities are vital components of our daily lives and to the development of the global economy. Some commodities have been in demand for centuries while others are trapped in a cycle of demand. For instance, the demand for aluminum jumped 48% this year which resulted in a significant increase in aluminum price. 

Another commodity that has been in the headlines over the last year is Uranium. So far this year, the price of Uranium jumped by more than 50%, largely due to the growing demand for Uranium in clean energy facilities and the inability of uranium producers to meet the demand

Below, you can find the top ten most traded commodities in the world as of 2021:

  1. Crude oil
  2. Coffee
  3. Natural Gas
  4. Gold
  5. Wheat
  6. Cotton
  7. Corn
  8. Sugar
  9. Silver
  10. Copper

FYI

The London Metal Exchange is the largest exchange market in the world for precious metals such as gold, copper, silver, lead, tin, and zinc. It is estimated that the total volume per year on LME is around $12 trillion.

What Events and Market Data Impact Commodities?

Like any other market, commodity prices are influenced by market news and data. At times of reports or news, commodities tend to respond to changes in supply and demand and to expectations of economic growth or recession. 

That said, the case here is a bit more complicated than in other markets. After all, some of the commodities are niche markets and you need to find the reports and data that have an impact on commodity prices. Obviously, the data and market you need to follow also depend on the product you decide to trade. 

Nonetheless, here are some of the main reports and data you need to follow to get an insight into the supply and demand of different commodities in the market. 

  • API Weekly Report (Crude oil, and petroleum products) – Published every Tuesday at approximately 4:30 pm ET.
  • Crude Oil Inventories Report by EIA (Crude oil, and petroleum products) – Published every Wednesday at 10:30 am ET.
  • Weekly Natural Gas Storage Report by EIA – ​​Published every Thursday at 10:30 am ET
  • OPEC Monthly Oil Market Report (Oil and petroleum products) – Published every month around the 12-15
  • The Commodity Futures Trading Commission (CFTC) Commitment of Trader Report (All commodities)  – Published every Friday at 3:30 pm ET
  • World Agricultural Supply and Demand (Soft commodities) – Published on the 10th of each month. 
  • USDA Crop Reports (Soft commodities) – Published on a weekly, quarterly, and yearly basis.

How to Start Commodity Trading?

As we mentioned previously, there are essentially two ways to get into commodity trading. The first way is to find a broker that gives you access to futures contracts that trade on the exchange. Clearly, there are major advantages of trading commodities via the exchange including access to a level 2 order book, and the ability to trade multiple futures on the same commodity with different expiration dates. For example, many traders will utilize futures spread, which is a technique in which a trader buys one contract of a certain commodity and sells the other future contract with two different contract months (e.g. – buying wheat May contract and selling Wheat December contract). 

Bear in mind, however, that for opening a futures investment account the majority of brokers require minimum deposits that range between $5,000 to $10,000. In addition, when trading futures contracts, you need to take into consideration fixed trading fees and exchange fees. 

Alternatively, you can find an online CFD broker that allows you to speculate on the price movements of commodity products. Here, at SwitchMarkets, we offer users to trade the most popular precious metals and energy products. These include Gold, Silver, Brent Crude Oil, WTI Crude Oil, and Natural Gas.

FYI

Crude oil is the most traded commodity in the world, with coffee as the second most traded commodity in the list. Wheat is the most traded grain commodity in the world.

Conclusion

As a former commodity trader, I must admit that the commodity market is my favorite one of all. Understanding the political factors that impact commodity prices is fascinating and could help you realize why some countries have close ties. The United States and Saudi Arabia, for instance, signed the famous Petrodollar agreement in 1973 that obligates Saudi Arabia to accept the US dollar as the one and only currency for pricing and settlement of oil exports. In return, the US has guaranteed to offer military protection to Saudi Arabia. So, clearly, the relations of these two countries have a huge impact on oil and petroleum products. 

What’s more? The Chinese are the biggest importers of crude oil and… guess who are the biggest exports? The United States and Saudi Arabia. It is therefore not surprising that the Trade War between the US and China has a direct impact on oil prices. Another example – Egypt is the largest importer of wheat while Russia, the US, and Canada are the largest exporters. So, these countries typically maintain close relations due to their need to buy and sell wheat. 

Generally, prices of commodities tend to move in the opposite direction of the stock market and the US dollar. The vast majority of commodities also tend to move together, partly due to their role as safe-haven assets and being vital materials for human existence.  

The bottom line, if you are a big fan of international relations and political economy, trading commodities could be the right place for you to start. It is an exciting market that offers lots of trading opportunities and huge potential to make profits. 

FAQs

How to get into commodity trading?

There are several ways to get into commodity trading. You can open an account at a broker that gives you access to a future exchange or find a CFD broker that allows you to speculate on prices of commodities with high leverage. Another way is to invest in commodity stocks or find commodity ETFs. But regardless of the way you choose to trade commodities, you need to learn what are the main factors that impact commodity prices, the pricing of each contract, and the key data that is being released and provide information about the asset you decide to trade.  

How to trade bitcoin futures on CBOE?

According to the CFTC, bitcoin is classified as a commodity, which means that you can trade bitcoin futures on the CBOE. Another way to trade bitcoin futures is via CFDs. 

What’s the best commodity for intraday day trading?

Fundamentally, any commodity that you will choose to trade can be traded intraday. However, for that purpose, you want to choose an asset that is liquid, volatile, and is widely covered in the mainstream media. Therefore, some of the best commodities for intraday trading include crude oil, natural gas, gold, and silver.

Is commodity trading good for beginners?

For beginner traders, commodity trading might be easier than the stock market as it does not require in-depth research and the picking of different financial instruments and stocks to trade on. Instead, it is a classic case of supply and demand, hence, you need to focus on one commodity, follow the important data that is being released on a weekly/monthly/quarterly basis, and understand the factors that impact commodity prices. 

Where should I start learning about commodity trading?

There are lots of courses online and free videos you can find on YouTube about commodity trading. Besides that, it could be very useful to open a free demo trading account and start trading with virtual money. This way, you can learn how to use a trading platform, find the commodities to trade on, and understand the price structure of each commodity. 

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