A Complete Guide to Trading Commodities, From Beginner to Active Trader
Commodity trading is the process of buying and selling natural resources. You can make money when the value of a commodity moves in the right direction.
Commodity trading is a way of investing in natural resources and, if you make the right moves, turn a profit. We allow you to play the commodity markets via your desktop or mobile device. However, before you can do that, you need to know what commodities are, how they work, and how you can trade them. This guide will explain the fundamentals of the industry and show you how to trade commodities at INFINOX.
What are commodities?
Commodities are materials or goods that occur naturally, and that humankind uses in some form or another. The most well-known commodities are gold, oil, and sugar. We’ve used the term “some form or another” because we don’t use gold in the same way as sugar. The core principle to understand here is that commodities are natural resources that have some value within societies around the world.
To fully answer the question, "What is a commodity?" we need to dive a little deeper.
Definition: A commodity is mined, extracted, reared, or harvested. It’s then manufactured and standardized for mass-market consumption.
Take oil, for example. Companies drill for oil, refine it, and sell it in barrels. Thus, the commodity has been extracted, manufactured, and sold as a standardized product (i.e. a barrel of oil). This process of turning naturally occurring resources into mass-market products allows them to be traded.
Oil can be traded by the barrel load on various stock exchanges. What’s more, because these barrels have a price, you can also trade commodities based on their value using CFDs (more on this later).
The final facet of commodities you need to understand is their categorization. In broad terms, the commodity market is split into two distinct categories: hard and soft commodities.
Hard commodities are naturally occurring resources that are mined or extracted. If the resource isn’t readily available above the ground, it’s a hard commodity.
The main hard commodities you can trade are:
- Iron Ore
- Natural Gas
A soft commodity is a naturally occurring resource, just like a hard commodity. However, these resources are grown, harvested, or reared. In essence, they are readily available above the ground.
The main soft commodities you can trade are:
- Orange Juice
What is commodity trading?
Commodity trading is the process of buying and selling natural resources. This doesn’t mean you can buy a single barrel of oil or 1,000 bushels of wheat and have them delivered to your door. You won’t be taking delivery of 100 barrels of oil, for example, when you trade commodities. When you buy precious metals such as gold and actually take ownership of them, this will give you exposure to the gold market. That's because, as its value changes, so too does the price you could sell your gold for. Generally speaking, though, that's not what we're dealing with here.
So how does the commodity market work? The market works on prices and contracts. We will break down the main ways to trade commodities in the following sections. However, the main premise you need to understand is that you’re buying digital contracts or speculating on price movements. That means you don’t own a barrel of oil or a bushel of wheat. But you can make money when the value of a commodity moves in the right direction.
How can I trade commodities online?
There are three main ways to buy and sell commodities. Remember, you aren’t buying the underlying asset. There are exceptions for precious metals, but you generally won’t own any physical resources. Instead, you can profit from the price movements of commodities using these trading mechanisms:
Contracts for Difference (CFD) commodity trading
We give you the option to speculate on the price movements of commodities, rather than buying the underlying asset. This is known as contracts for difference (CFD) trading. The term CFD describes the process you engage in. You’re entering into a virtual contract with a broker (us) and making an agreement to sell the contract at a time of your choosing.
The difference between the purchase price and the sale price is where you make a profit or loss. These prices are determined by the market value of the commodity you’re trading. Let’s say the price of oil is $50/barrel and you invest $50 in an oil CFD. After one week, the price of oil goes up to $60. If you sold your CFD at this point, you’d make $10 profit ($60 sale price - $50 purchase price = $10 difference).
The advantage of trading commodities via CFDs is that you can take the upside or the downside by doing one of the following:
- If you think the price of a commodity will increase, you can “buy” an opening position. This means you are happy to buy a contract at the current price because you believe you can sell for a higher price in the future.
- If you think the price of a commodity will decrease, you can “sell” an opening position. This means you’re happy to sell a contract at the current price because you can buy it back (in theory) at a later date for less money. Thus, you’ve sold it for more money than it will cost to buy back the product.
Using the above strategies, you have a way to make money when the value of a commodity increases or decreases. It’s this level of flexibility that makes CFDs popular and the go-to mechanism for trading commodities at INFINOX.
Exchange Traded Funds (ETFs) commodity trading
Exchange traded commodities are mutual funds that track the price of a commodity or collection of commodities. They are referred to as funds or mutual funds because they combine money from multiple investors. Everyone’s money is put into a communal pot. The money in the pot is used to buy futures contracts or stocks that relate to a particular commodity or collection of commodities.
As the price of said commodity increases, investors make money. If the value of a commodity decreases, the opposite happens. Therefore, the value of your investment will run in line with the price movements of the commodity in focus.
The benefit of exchange traded commodities is that they spread your risk. If the fund is used to invest in stocks, the money could be split across 20 companies that deal in oil. This strategy can negate a bad run for one company if stocks in the other 19 are strong, for example.
Stocks commodity trading
Another way to trade commodities is through stocks. For example, Company A might deal primarily in gas. You can buy shares in Company A for £50. If the value of gas increases, it follows that Company A should be more profitable as its main resource is more valuable. In turn, the value of Company A’s shares will go up.
Playing the commodity market via stocks is an indirect way of tracking price movements. The advantage is that a company may have a range of interests. It may deal with gas, but also have interests in oil and solar energy. In this case, a negative run for the price of gas may not be as detrimental to your investment than it would be if you’d simply bought gas CFDs.
The downside to buying stocks is that you’re bound by their value. If Company A’s shares cost £50, you have to pay £50 per share because you’re buying into the company. You own that share. Therefore, if the value of the company is high, you might not be able to afford any shares. In contrast, CFDs aren’t fixed in the same way. You can trade at a level that suits you. Thus, if you’re a novice investor, CFDs can be a more accessible way to enter the commodities market.
Trading energy commodities
Energy Commodities are the most traded natural resources. Oil and gas power everything from our cars to our homes. Therefore, there is always a demand for these commodities. That makes the markets extremely active but also volatile.
Oil is a finite resource, so its value is almost always high. However, due to economic shifts, global demand, and supply, oil prices can also be volatile. That makes it popular with commodity traders who understand the market. You can use CFDs to trade oil’s spot price which means you can speculate on its value increasing or decreasing.
Natural gas trading
Gas is the second most used type of energy. Approximately 22% of the world’s power needs are met by natural gas. That high level of supply and demand creates plenty of opportunities to trade. These dynamics can also make the price of gas volatile. Therefore, it can be a great commodity to trade via CFDs.
Trading precious metals
Precious metals are traded because of their value as a product and a concept. As gold and silver can be used in products such as jewelry, they have a practical value. However, gold and silver are also used as stores of value. In other words, they’re a concept in the same way a £10 note has an agreed store value when exchanged between two parties.
Gold commodities are popular because this precious metal’s value extends beyond its use in the jewelry business, dentistry, and electronics. Although gold derives some of its value from its practical applications, it obtains the bulk of it through its position as a proxy for money.
Central banks hold gold as a store of value, as do individuals. This means that fiat currencies (e.g. GBP) compete with gold. If a currency weakens in value, gold’s price increases. This interplay between money and gold is what makes it valuable and a popular commodity to trade.
Silver is a precious metal that’s traded for two main reasons. Firstly, it has an inherent value due to its uses in the jewelry industry and for industrial products such as batteries and circuits. Secondly, people trade silver as a way of mitigating risk. When economies are in trouble and hyperinflation is a risk, silver has the potential to hold its value and offer better returns than stocks because it’s a finite resource.
What affects the price of commodities?
The commodity market can change at a rapid rate, particularly if the resource is in high demand or affected by outside factors. For example, oil is a finite resource. So, as it becomes harder to find, its value will increase. However, the price of oil can also be affected by people needing less fuel for their cars. These competing forces cause volatility which, if you understand the markets, can be an advantage.
The price of a commodity will be affected in different ways. However, the main factors that can impact the price of commodities are:
Supply and demand
If a product is scarce, a finite resource, or difficult to obtain and process, its value can be high. Similarly, if demand outweighs the supply, it becomes a more valuable commodity. The inverse is also true. If supply outweighs demand, the value decreases.
Weather and climate
Certain commodities can be affected by the elements. Take wheat, for example. If the conditions are too wet or too dry at crucial times throughout the year, crops can suffer. When fewer crops are available, supply is low and if demand remains high, the value increases. Soft commodities are particularly susceptible to weather conditions.
The value of money can affect the price of commodities. Because commodities are traded between countries, the value of both currencies involved can impact the value of what’s being sold. For example, if the value of one currency is strong and the other is weak, the former has more purchasing power. Therefore, it can buy commodities at a better price and that drives down its overall value.
Politics and government policies
If a new law is brought in or a country is facing a crisis, the value of commodities can change. For example, there is currently a push to promote green energy and phase out fossil fuels such as oil. As governments introduce policies aimed at reducing fossil fuel consumption, it will reduce their value.
Commodity trading FAQs
Is commodity trading good for beginners?
Using CFDs can be a great way for beginners to enter the commodity trading market because they allow you to speculate on positive and negative price movements. What’s more, we have plenty of trading guides and resources to help you learn more.
Which commodity is best to trade?
Precious metals and energy commodities are among the best to trade because there’s a lot of liquidity in the markets. However, you should always choose the commodity market that suits your own preferences and interests.
How can I trade commodities online?
You can create an account with us. Joining INFINOX allows you to trade CFDs on a variety of commodities, including gold, oil, and gas. You’ll also be able to trade other financial instruments, including forex, indices, and equities via your desktop or mobile device.
This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorized to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.