Are you looking to start trading commodities? Then you should really take the time to go through our guide before you continue. We will help you figure out which method will suit you and your trading style best, provide examples of our favorite way of investing in commodities, and offer you a lot of practical and very useful tips.
What are commodities?
First off, let’s clarify what commodities are and why people trade them. A commodity is a product that is used by humans in everyday life. Typically, it’s something that we can buy ourselves at the grocery store or the gas station such as corn or oil but it can also be a precious metal such as gold. Generally speaking, a commodity has the power to influence the way you live and spend your money and it’s an integral part of our society.
There are hundreds of tradable commodities that one can invest in and most people divide those commodities into the following categories.
- Energy commodities are products used to create energy to run our vehicles, factories, and even homes. Crude brent crude, gasoline, and natural gas are typical examples of energy commodities.
- Metal is a category that includes every available metal there is in the world, and it’s one of the more popular types of commodities to trade. Gold and silver belong to the most traded commodities.
- Agriculture includes the most influential crops and produce that is grown around the world. For example, you can trade corn, soybeans, coffee, sugar, and cotton.
- Livestock and meat are exactly what it sounds like, meat products. Live cattle, pork bellies, and hogs are some of the most traded livestock commodities on the market.
As mentioned, there are hundreds if not thousands of commodities that one can trade, and the above-mentioned are only a few examples of popular commodities. To learn more about what products you can invest in, we suggest you check out the 10 most traded commodities or our general introduction to commodities.
However, if you feel ready to learn more about how one can actually trade commodities, we suggest you continue reading.
How To Invest in Commodities
Back in the days, commodity trading was a highly exclusive form of investment since one had to buy the actual commodity in large quantities to make any profit. This required a lot of money to fund the investment, great knowledge of the commodity so that you could handle it correctly as well as a lot of space to store it in. As you can imagine, only a small group of people had access to this and commodity trading wasn’t available to the everyday person. Today the market looks different, and you can choose to speculate on commodity prices using several more practical and efficient investment methods.
1. Contract for Difference
For the longest time, our favorite way of trading commodities has been by using contract for difference (CFD). CFD is a speculative form of investing that can be applied to any market and underlying asset. It’s a very versatile investment method that is easy to learn and highly profitable for the people who master it.
The idea behind CFD trading is that you invest your money based on whether the price of a commodity will increase or decrease. In other words, your job is to predict in which way a price will move and then bet your money on that.
CFD trading allows for leverage to increase possibilities and the best part is that you can be trading commodities and stocks at the same time, on the same platform in order to benefit from the most optimal investment options at any given time. Also, CFDs are perfectly suited for both long and short trading.
To start trading commodities as CFD, you need to set up a trading account with a CFD broker. We have dedicated this website to recommending the best brokers in the world, and the following three belong to the absolute top class of CFD commodity brokers.
- eToro is a social network platform that you can use to invest in six different commodities (copper, gold, natural gas, crude oil, platinum, and silver) as well as a large selection of other assets.
- Plus500 is a renowned broker based in Tel Aviv and London. Their selection of assets includes 17 commodities such as cotton, coffee, and gold as well as over 2,000 other securities.
- Markets.com offers thousands of underlying assets, including 15 of the world’s most popular commodities. Their platform is also one of the best in the world.
Today, the most common way of trading commodities is by using futures contracts. Futures are contracts that let you invest in commodities without buying the commodity at the time of the trade. Instead, you make a promise to buy a certain amount of commodities for a certain price in the future, and in most cases, you sell the commodities before you get them.
Generally, there are two ways one can invest in futures. The first is hedging where one buys commodities to protect an investment or secure a price. This is mostly done by companies that buy large quantities of a commodity that they use in order to guarantee a specific price. A good example is airlines who often buy jet fuel in enormous quantities to avoid having to pay more for it in the future.
The second way is speculative futures trading, which is what you will be doing. This is done with the sole purpose of making a profit from the difference in buy and sell price. The difference between hedging and speculative trading is that you sell you contracts before they run out when you speculate.
One of the main advantages of futures trading is that you can easily trade long and short.
How do you trade futures?
In the past, futures were traded on futures exchanges, but today only a few of the original exchanges are left since most of them have been bought by the leading stock exchanges in the world. Because of this most futures are traded on stock exchanges these days.
3. Exchange Traded Funds
Exchange traded funds (ETFs) are securities that trade just like stocks on stock exchanges which means they’re quite easy to learn how to use. Normally, an ETF follows the price of a commodity or a group of commodities but instead of buying a futures contract, you buy a share that represents the price of the underlying commodity.
Due to the fact that ETFs are traded as stocks, they’re great for day trading and a good way of diversifying your portfolio. Also, ETFs can be traded using leverage and margin and can quite easily be used for short trades.
Lately, some brokers have decided to take ETF trading on commodities to the next level by offering them as CFDs, meaning you can speculate on ETFs even easier than before.
Plus500 is one of the few regulated CFD brokers that offer ETFs as a part of their selection today and at the time of writing they have roughly 50 ETFs on offer. IQ Option is also working on a brand new ETF product and according to their website they will start offering them “soon,” however, no exact date has been set.
Exchange Traded Notes
Exchange traded notes (ETNs) are similar to ETFs but much less popular. ETNs are also traded like stocks and just like ETFs they mimic the fluctuation of underlying assets and they’re traded on major exchanges such as Nasdaq and the NYSE. One downside with ETNs is that they are affected by the credit score of the issuer, meaning their prices are affected by more than just the underlying asset.
A popular and alternative way to invest in commodities is stock trading. But how does that work? Well, when you trade commodities using stocks you don’t actually invest in the
commodity. Instead, you invest in companies that handle commodities or companies that operate within an industry. Since the stock price will be affected by the price of the commodity, you are indirectly trading commodities using stocks. Let us use an example to describe what we mean.
If you’re interested in investing in crude oil, but you’re not sure of how futures work, you can invest in a company that drills for and sells oil, for example, BP or Shell. When the price of crude oil fluctuates, the stock prices will be affected too.
As you probably already know, stocks are sold on stock exchanges around the world but stocks can also be traded as CFDs. All of our recommended CFD brokers offer stock trading, although the selection varies quite drastically. A great benefit of buying stocks as CFDs is that you can invest as much money as you feel comfortable with and you’re not forced to pay full price for any stock.
A Summary of Methods for Commodity Trading
What makes commodities different from many other securities is that they can be traded using so many different methods, and we hope you have a better understanding of your options.
As mentioned, we prefer trading commodities as CFDs due to the fact that it is so practical and easy to get started with, although, we suggest you educate yourself on futures trading as well. Also, don’t forget that commodity trading is associated with high risk and that you need a great understanding of the market before you start investing. To learn more about investment strategies, we recommend you check out our educational material as well as our commodity and CFD trading guides.