menu search

1 Answer

Commodity trading may be new to many of you, but at the end of the day, it's a lot like trading any other financial instrument. The first thing to do is choose a broker . There are CFDs markets, futures markets and a whole host of options markets that can help you access the commodity markets. To help you make this decision, just look at how much money you have available to trade.

Size matters (when it comes to trading commodities)

Size matters when it comes to raw materials. This is due to the futures markets. Futures markets are defined contracts that give you the ability to trade multiple commodities. To make a trade in the commodity market of your choice, you must have the necessary margin to open this position, just like in the world of Forex. It is in this situation that the futures markets could be a bit expensive for some people. While some commodities are cheaper to trade than others, some require an initial margin of over $5,000 for a contract. Beyond that, standardized contracts mean that there is only one tick value available. For example, if you are selling crude oil, each tick is worth $12.50.

This is where CFD brokers come into play. Contracts for difference allow you to trade less than a full contract, mainly because you are not actually trading in the futures market. You negotiate a contract with your broker to pay or receive the difference between the open price and the close price. This is why your broker may offer you the equivalent of a bale of wheat compared to the standard contract size, for example. In this sense, CFD brokers can be a good option to consider.

A final option may be to trade commodities in the options markets , but lately options have been extraordinarily volatile and expensive. Likewise, binary options have gotten a lot of bad press lately and in general they can be extraordinarily dangerous due to the large amount of leverage they offer.

Fundamental factors differ

Remember that the fundamentals of commodity markets can be very different from what you are used to if you are a stock trader or currency trader. Indeed, these are real "things" that do not necessarily concern businesses or economies. To take an example, several years ago there was a long series of floods along the Mississippi River and in the surrounding region of the United States. This had a big effect on the price of wheat, as flooding became a problem. The destruction of crops reduced the supply of wheat on the market, which naturally led to an increase in prices.

This is why the so-called "soft" commodities in the futures markets, which are generally products that grow on the ground, can be a bit difficult to trade for some traders, as weather conditions become very important. Usually, when a currency is traded, you don't have to worry about the weather unless there is an anomaly like a tsunami in Japan. In general, the weather rarely enters the equation for Forex traders. However, agricultural commodity traders trading wheat, corn, soybeans and many other commodities are totally dependent on weather reports.

Precious metals are also a completely different financial instrument, as they often react to Federal Reserve interest rate expectations. Similarly, the price of metals is directly affected by the strength of the dollar, as most major precious metals markets are denominated in this currency. This is why it is very important that you know how volatile the US dollar is before you trade gold, silver or other metals.

Liquidity varies

Another element to take into account when operating in the commodity markets is the liquidity of the market where they are traded. The fact that your futures broker offers the timber markets does not mean that you have to participate in them, as they are very illiquid and are generally used for hedging purposes more than anything else. This is not the place where retail traders can participate. There is a contrast with the EUR/USD pair and you can notice that there is a big difference between opening and closing a position. Many retailers have been affected by the lack of liquidity in a market they don't understand.

Stay true to what's important

It's really funny that I recommend this because I don't think that's the case in the currency markets (although many traders will argue otherwise). This is because commodity markets have variable liquidity and if you are involved in a futures contract, this liquidity can hurt you, as the value of a tick can be extraordinarily large in some of these contracts. This is why traders should trade assets such as crude oil, gold, silver, corn, wheat, soybeans, natural gas, etc. Participating in the sale of milk, wood or even palm oil may seem exotic and therefore intriguing, but it is a great way to lose money.

This doesn't mean you can't trade these commodities, but you will need an account of the right size. Ultimately, it's best to stick with much more stable markets.

In summary

Find a broker , which hopefully is regulated by a strong market authority, or a broker you already have that offers CFD markets. As a retail trader, it is best to start out using CFDs, as you can trade ticks of pennies, compared to the large positions that are required in some markets. Remember that technical analysis, to some extent, works the same in all markets. The more liquid the market, the more the analysis is likely to work. That's the beauty of some commodity markets like crude oil, because they're very technical in nature.
Welcome to InvestmentKit Q&A, where you can ask questions and receive answers from other expert members of the community.