How to Become a Commodity Trader

How to Become a Commodity Trader

Iron ore, crude oil, and precious metals are examples of commodities that are the building blocks of the world economy. Although commodities have distinct chances for astute investors to profit from their volatile prices, investment in them can be riskier than investing in more traditional assets such as equities and bonds and requires specialized understanding.

Defining Commodity

Commodities, such as mineral ores, fossil fuels, and agricultural products, are the raw materials utilized to make completed items. Commodities are tangible products that are purchased, sold, and exchanged in financial markets; in contrast, securities like stocks and bonds are just financial contracts.

Four primary categories of commodities exist:

  • Energy: The market for energy includes uranium as well as coal, ethanol, oil, and natural gas. Renewable energy sources like solar and wind power are also considered forms of energy.
  • Metals: Precious metals such as gold, silver, palladium, and platinum, as well as industrial metals like iron ore, tin, copper, aluminum, and zinc, are examples of commodity metals.
  • Products from agriculture: Agriculture includes both non-edible items like cotton, palm oil, and rubber as well as edible ones like chocolate, grains, sugar, and wheat.
  • Livestock: Livestock refers to any living animal, including hogs and cattle.

Commodity prices fluctuate continuously due to changes in supply and demand dynamics in the global economy. Grain prices could rise as a result of the conflict in Ukraine, but the price of oil could fall overall if Middle Eastern production continues to rise.

Profiting from supply and demand patterns or lowering risk through portfolio diversification by holding a variety of asset classes are the two main goals of commodity market investors.

“Differentiated exposures from the stock market and the potential for inflation protection are the real advantages to commodity trading,” states Ryan Giannotto, director of research and certified financial analyst (CFA) at GraniteShares, a New York City-based ETF issuer.

Commodity Trading: A Brief Overview

The exchange of various assets, usually futures contracts, based on the price of an underlying physical commodity is known as commodity trading. By purchasing or disposing of these futures contracts, traders place wagers on the anticipated future worth of a specific commodity. They purchase specific futures assets, or go long, if they believe the price of a commodity will rise, and they sell off other futures, or go short, if they believe the price of a commodity will drop.

Given the significance of commodities in everyday life, trading in commodities started long before the emergence of modern financial markets, when ancient civilizations established trade routes for the exchange of goods.

“Commodities trading is properly the birthplace of modern investing.” Claims Giannotto. 

At the Chicago Board of Trade, modern commodity trading got its beginnings in the United States in 1848. Instead of just locking in low prices during harvest, it enabled farmers to set sales prices for their grain at various times during the year. Through futures contracts, both the buyer and the farmer were protected from price fluctuations by pre-agreeing on a price.

The commodities market is far more complex today. In addition to being an international market with exchanges all around the world, it also offers a vast array of different commodities for trading. During the workweek, you are able to trade commodities almost around the clock.

Guide to Trade Commodities 

You can trade commodities in your portfolio via a few different methods, each having pros and cons of their own.

Futures for Commodities

The most popular method for trading commodities is using a futures market to purchase and sell contracts. This involves you and another investor entering into a contract that is contingent on the future price of a commodity.

You might accept a commodity futures contract, for instance, to purchase 10,000 barrels of oil at a price of $45 a barrel in 30 days. Instead of transferring the actual products at the conclusion of the contract, you terminate it by entering an opposing position on the spot trading market. In this case, you would close out the position by entering a new contract to sell 10,000 barrels of oil at the going rate of the market when the futures contract expires.

You would win if the spot price turned out to be greater than the $45 a barrel contract price; if not, you would lose money. In contrast, you would profit when the spot price of oil went down and lose money when it went up if you had signed a futures contract to sell it. You may terminate your employment at any time prior to the contract’s expiration date.

You must open an account with a specialty brokerage account that allows these kinds of trades in order to participate in futures trading.

“Brokers who have an account with a brokerage firm that offers futures and options can access these markets,” says Craig Turner, senior commodities broker at Chicago’s Daniels Trading. Every time you initiate or end a position in commodity futures trading, you will be required to pay a commission.

Physical Commodity Purchases

You are not purchasing or selling the actual physical commodity when you trade futures contracts. Futures traders only speculate on fluctuations in price; they do not actually accept delivery of millions of barrels of oil or herds of live animals. Individual investors however, acquire the actual products, such as gold bars, coins, or jewelry, when it comes to precious metals like gold and silver.

With these investments, you may experience the real weight of your investments and have exposure to commodities like gold, silver, and other precious metals. However, compared to other investments, transaction costs are higher for precious metals. This approach works best with commodities that have a high value, such gold, silver, or platinum. Investors will still pay significant markups over the retail market’s current pricing, according to Giannotto.

Commodities Stocks

Purchasing stock in a business engaged in the commodity business is an additional choice. You may invest in the shares of an oil drilling or refinery company for oil, or you could buy into a sizable agriculture company or one that sells seeds for grain. These stock investments track the underlying commodity’s price. An oil company’s share price should increase in tandem with an increase in oil prices if it is more profitable.

Since you aren’t merely speculating on the commodity price, investment in commodity stocks has less risk than investing directly in commodities. A well-managed business could still turn a profit even if the commodity loses value. However, this is reciprocal. An oil company’s stock price may benefit from increased oil prices, but there are other considerations as well, such as management style and overall market share. Purchasing stocks is not a perfect fit if you are searching for an investment that precisely matches the price of a commodity.

Commodities ETFs, Mutual Funds and ETNs

Commodity-based funds include mutual funds, exchange-traded funds (ETFs), and exchange-traded notes (ETNs). These funds pool the capital of numerous small investors to create a sizable portfolio that attempts to track the price of a commodity or a basket of commodities; an energy mutual fund, for instance, is based on a number of energy-related commodities. The fund may invest in the equity of several commodities-exposed companies or purchase futures contracts to track the price.

Giannotto claims that commodity exchange-traded funds (ETFs) have democratized the commodities trading game for all investors due to its affordability, accessibility, and high liquidity.

Compared to trying to develop the portfolio yourself, you may access a far wider choice of commodities with a minimal outlay. In addition, a qualified investor will be in charge of the portfolio. Nevertheless, the commodity fund will charge you a management fee in addition to what it would have cost you if you had made the investments yourself. Furthermore, the fund’s strategy may prevent it from precisely tracking the price of the commodity.

Commodity Pools and Managed Futures

Private funds that can invest in commodities include managed futures and commodity pools. They work similarly to mutual funds, but a lot of them aren’t listed on exchanges, so getting into one requires approval.

These funds have a larger potential return than mutual funds and exchange-traded funds (ETFs) because they can employ more sophisticated futures trading strategies. The management expenses could also go up in return.

The Difference between Commodity and Stock Trading

Leverage is used far more frequently in commodity trading than in stock trading. This implies that you only provide a portion of the total amount required for an investment. For instance, you might deposit 10%, or $7,500, in lieu of the whole $75,000 required to cover the entire amount of an oil futures contract.

Based on the anticipated value of the trade, the contract will mandate that you maintain a minimum balance. You would be subject to a margin call and would have to make further deposits to get your account balance back up to the minimum amount needed for the trade if the market price started to move in a way that made losing money more likely. Small price moves lead to big changes for your investment return, meaning your potential for gain in the commodity market is high but so is your potential for losses.

Commodities also tend to be a short-term investment, especially if you enter a futures contract with a set deadline. This is in contrast to stocks and other market assets where buying and holding assets long term is more common.

In addition, you have more time to make trades with commodities because markets are open nearly 24/7. With stocks you primarily make trades during normal business hours, when the stock exchanges are open. You may have limited early access through premarket futures, but most stock trading occurs during normal business hours.

Overall, commodity trading tends to be more high-risk and speculative than stock trading, but it can also lead to faster, larger gains if your positions end up making money.

Why Invest in Commodities?

The ideal investment option for experienced investors is commodity investing. You must thoroughly comprehend commodity price charts and other research methods before you make any transactions. You also need to have a high risk tolerance, which means you can endure short-term losses in the hope of long-term rewards, because market price movements can result in significant gains and losses. Additionally, investing in commodities should only make up a small percentage of your overall portfolio.

To determine whether investing in commodities is good for you and to seek advice on the best tactics to employ, think about consulting with a financial advisor as you would with any decision.

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