Commodities are raw materials, such as oil, gas, metals, and coffee. What they are not is manufactured goods such as steel, cars, or breakfast cereal. However, the latter is directly affected by price movements in the former. For example, if the price of crude oil rises, it affects the cost of vehicle ownership, which in turn impacts the value of car sales. Since commodities are a fundamental part of modern life, the commodities trading market is an interesting place for traders, amateur and professional alike.
Online trading platforms have made commodity trading accessible to everyone, but this is not a market to dabble in if you have no knowledge of how the commodities markets work. Commodities are highly leveraged, so commodity trading can be risky for inexperienced traders, with the potential of huge losses never too far away.
Different Types of Commodities
As we have already explained, commodities are raw materials. You can trade in most commodities, but the main categories are metals, energy, agriculture such as wheat and cotton, and livestock and meat, i.e. cattle and hogs.
Why Trade Commodities?
The commodities market has long been seen as a safe haven in troubled times. It is common for investors to flock to gold and silver when the stock markets are in a downward spiral thanks to economic and/or political uncertainty. Gold always has an underlying value and can be traded, whereas stocks may become worthless in extreme circumstances.
Commodities prices typically run in the opposite direction to stock markets. So, if the FTSE-100 is bearish, the price of gold will likely be bullish.
Opening a Trading Account
To begin trading in commodities, you will need to open a trading account with a reputable broker that offers a commodity trading platform. This is easy to do thanks to a host of online brokers and trading platforms, but most reputable brokers have a serious of checks in place to prevent inexperienced traders opening a highly leveraged trading account and losing far more than their initial investment. Expect to have your credit report checked, among other things.
Different Ways to Invest in Commodities
If you want to invest in commodities, there are several different ways to do it.
In the case of precious metals such as gold, you can physically own the commodity. For example, you might choose to invest in gold coins or bars. However, this isn’t an option with many other commodities such as energy or agriculture. Although, feel free to invest in some cattle or hogs if you have a few acres of land!
The futures market is a popular way to invest in commodities. You can buy a futures contract where you agree to buy or sell at a particular price on a set date in the future. Futures contracts are common in the energy sector.
Exchange Traded Funds (ETFs) are another popular commodities trading vehicle. ETFs are traded like stocks. They track price movements and allow investors to capitalize on price fluctuations without committing to a future price or owning the commodity.
Finally, if you prefer to invest at arm’s length, look for a mutual fund that invests in the stock of a company operating in the commodities sector, e.g. Shell.