HOW TO TRADE COMMODITIES

KNOW
COMMODITIES
TRADING
INSIDE OUT

HOW TO TRADE COMMODITIES

KNOW
COMMODITIES
TRADING
INSIDE OUT

WHAT ARE
COMMODITIES?

A commodity is a raw material used in the manufacturing of more complex products called finished goods. Commodities can be either soft (grown or raised, such as agriculture and livestock) or hard (those that can be extracted or mined, such as metals and energy).

A quick history lesson: commodity trading dates back to ancient civilisations, who used to physically trade metals, spices, seashells, agriculture products and animals. In particular, it originates from Sumerian technological inventions such as maths and ‘bulla’, a hollow clay ball that was used as a verification device. The bulla is the earliest equivalent to futures contracts, i.e., to buy and sell an asset at a specific time in future at a pre-agreed price and quantity.

Since then, commodity markets have become more complex, although the basics around commodity trading have remained the same. In modern times, commodity trading is performed both physically and virtually in various trading ways, one of which is contract for differences (CFDs), i.e., speculating on the rising or falling prices of different commodities.

Commodities Image

TYPES OF COMMODITIES

METALS VS ENERGY
VS AGRICULTURE

From transportation and housing to our big cup of morning coffee, our everyday life relies on the existence of commodities. What separates commodities from other goods is their interchangeability with other assets of the same type. In this context, the place of extraction of the average 5 grams needed to produce a gold ring plays no role in its value. Additionally, some standards, like the Gold standard, guarantee the quality of the commodities and set their values.

Metals Icon

Metals

Metal commodities are primarily used in manufacturing, construction and jewellery. Gold and silver are among the precious metals being traded.

Energy Icon

Energy

Energy commodities play a crucial role in keeping the global economy ticking over. Examples of energy commodities include crude oil, heating oil and natural gas.

Agriculture Icon

AGRICULTURE

Agricultural commodities are crops and animals that are grown or raised. Most agricultural commodities are used to produce food. Examples of agricultural commodities include cotton, cocoa, coffee and wheat.

WHAT DRIVES COMMODITY PRICES?

THE LAW OF SUPPLY
AND DEMAND

Every type of commodity is affected by unique factors, but, in any case, the main driver of their prices is supply and demand. Higher demand means a higher price for a commodity, while a commodity surplus will result in a price decrease.

Let’s explore the major factors that may affect supply and demand.

Demand Supply Image
Demand Supply Farsi
Demand Supply Chinese

Economic performance around the world

Economic growth boosts the demand for commodities while recession reduces demand.

Emerging markets/economies

Additional demand is created during the economic expansion of emerging markets, driving the respective commodities’ price.

Consumer & manufacturing trends

The growing popularity of avocado – the king of Instagrammable brunch – and its superfood qualities has set a high demand for the fruit (yes, it falls under fruits the same way the tomato does). As a result, the price of avocado has rocketed in recent years, showing that consumers can significantly affect the demand and supply of commodities and, respectively, their prices.

Furthermore, when a commodity becomes more expensive, buyers will look for suitable and less costly alternatives. Buying the substitute reduces the demand for the original commodity, decreasing its price.

Global crises

Crop failures, health crises such as the COVID-19 pandemic or natural disasters such as an earthquake may significantly affect demand.

Government intervention

Production constraints, such as oil supply cuts, can play a part in commodities price movements.

Geopolitical events

Wars, trade wars, conflicts, financial crises, terrorist attacks, and climate change can impact commodity supply and demand.
INDULGE IN AVOCADO

TRADING
INSIGHTS

Trading isn’t just about numbers – reading is very important too! Do you want to learn more about what affects prices of commodities, including avocado? Check out the Eurotrader blog for all the insights you need to make better trading decisions. You’re welcome.

ADVANTAGES AND RISKS

WHY TRADE
COMMODITIES

While there is a range of reasons to start trading commodities, there are two strong cases to trade commodities: inflation hedging and portfolio diversification.

Inflation Icon

Hedge against
inflation

Inflation is the rate at which currencies depreciate, meaning that today’s money will have less purchasing power in the future. In other words, it will cost more money to purchase the same amount of a given commodity at a later date.

Hedging is a risk management strategy carried out by taking a position in one market to reduce losses in case of an adverse price movement in a contrary market. Investors usually invest in precious metals as a hedge against periods of high inflation.

Portfolio Icon

Portfolio diversification

Diversification is another risk management strategy carried out through the allocation of funds into multiple assets, and is essential regardless of the trading strategy that someone follows. Traders need a diversified portfolio beyond traditional securities. As commodities prices tend to move in opposition to stock prices, some traders also rely on commodities during periods of market volatility.

CFDs Icon

CFDs on
commodities

CFDs provide an efficient way to trade popular commodities due to higher leverage, enabling a trader to use less capital to gain greater exposure. Speculating on the price movements without taking actual ownership of the commodity itself is also an advantage.

CFD trading typically comes with leverage too, which means you can open a trade with just a fraction of the asset’s total value. However, leverage is a double-edged sword: while it can magnify your gains, it can also magnify your losses.

Risk Management Icon

Risk
management

Commodities are one asset class you can use to diversify your portfolio and better manage risk. When it comes to risk management, you must be mindful that trading commodities may entail high risk. Commodities are associated with the highest level of volatility when compared to the other major asset classes, largely because the commodities market is impacted by unforeseeable events, both natural and human-induced. When commodities are traded using futures contracts, significant volatility and large fluctuations in price may occur.

Inflation Icon

Hedge against
inflation

Inflation is the rate at which currencies depreciate, meaning that today’s money will have less purchasing power in the future. In other words, it will cost more money to purchase the same amount of a given commodity at a later date.

Hedging is a risk management strategy carried out by taking a position in one market to reduce losses in case of an adverse price movement in a contrary market. Investors usually invest in precious metals as a hedge against periods of high inflation.

Portfolio Icon

Portfolio diversification

Diversification is another risk management strategy carried out through the allocation of funds into multiple assets, and is essential regardless of the trading strategy that someone follows. Traders need a diversified portfolio beyond traditional securities. As commodities prices tend to move in opposition to stock prices, some traders also rely on commodities during periods of market volatility.

CFDs Icon

CFDs on
commodities

CFDs provide an efficient way to trade popular commodities due to higher leverage, enabling a trader to use less capital to gain greater exposure. Speculating on the price movements without taking actual ownership of the commodity itself is also an advantage.

CFD trading typically comes with leverage too, which means you can open a trade with just a fraction of the asset’s total value. However, leverage is a double-edged sword: while it can magnify your gains, it can also magnify your losses.

Risk Management Icon

Risk
management

Commodities are one asset class you can use to diversify your portfolio and better manage risk. When it comes to risk management, you must be mindful that trading commodities may entail high risk. Commodities are associated with the highest level of volatility when compared to the other major asset classes, largely because the commodities market is impacted by unforeseeable events, both natural and human-induced. When commodities are traded using futures contracts, significant volatility and large fluctuations in price may occur.

STAY UP TO SPEED WITH
OUR DAILY TRADING
NEWSLETTER

COMMODITY CFD EXAMPLE

TRADING
COMMODITIES
IN PRACTICE

After having made your trading plan plus your research and learnt as much as possible about commodities and CFDs, it is now time to make your move. If you still find difficult or confusing to make a CFD trade, let’s look at the following example where Ben (our trader) thinks that the price of gold (XAU) will rise against the USD. The underlying commodity asset is XAUUSD.

1

Let’s suppose that XAUUSD is trading at

Bid Price (SELL price)
$1785.53
Ask Price (BUY PRICE)
$1785.64

2

You choose to open a buy (go long) position of 100oz.

3

Calculate your profit or loss by multiplying the amount the market moved by your trade size in USD per point.

Graph 1
Graph 1 Farsi
Graph 1

XAU price rises to 1795.64 & you close your trade. You make a profit of USD 1000.

+10 Points

Subtract spreads, swaps & commissions (depends on account type) for the

final profit.

Graph 2
Graph 2 - Farsi
Graph 2

XAU price falls to 1775.64 & you close your trade. You make a loss of USD 1000.

-10 Points

Add spreads, swaps & commissions (depends on account type) for the

final loss.

COMMON TERMS

COMMODITY
TRADING GLOSSARY

An item with economic value (money, land, property) owned by someone.

A contract for difference is a trading contract allowing the trading parts to speculate on an asset’s price movement, paying the difference between the asset value at the beginning and the end of the contract.

A risk management strategy carried out through the allocation of funds into multiple assets.

A trading contract to buy and sell an asset at a specific future time, at a pre-agreed price and quantity.

Natural resources, often mined, extracted or refined, such as gold, silver, oil, gas.

A risk management strategy carried out through taking a position in one market to reduce losses in case of an adverse price movement in a contrary market.

A trading strategy of using borrowed funds to increase a trading position and get more significant exposure to the market, greater than the initial amount deposited to open the position.

Commodities grown or raised, such as cocoa, sugar, wheat or corn.

A similar-enough or identical product used in place of another.

In trading, volatility is the statistical measure of how much prices rise and fall at a given period for a given asset or market, often linked to significant swings.

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