Commodity trading is one of the oldest markets, attracting speculators for centuries. However, it is also a highly volatile market with the prices affected by both local and global events, such as politics, currency fluctuations, taxation changes and even natural disasters and climate changes. Understanding the basics of commodity trading can help you become successful as a trader in this market.
What is Commodity Trading?
Commodity training is the speculating in primary or raw materials which are used to create products. The trader does not take physical possession of the commodity, but rather trades on an exchange. Commodities fall under four categories – energy (includes oil products, natural gas and gasoline), metals (includes precious metals such as gold and silver, as well as raw materials such as iron and copper), livestock’s (includes live cattle’s, as well as raw meat products) and agriculture (includes food grains, sugar and cotton). The most popular and commonly-traded commodities include gold, coffee and crude oil.
Understanding Leverage, Margins and Futures
Before you get started, it is important to understand what leverage, margins and futures are in relation to commodity trading.
- Leverage – Leverage is offered by brokers to allow you to trade larger market positions than your capital would allow. If a broker offers leverage of 100:1, that means that for your $1,000 of capital, you can trade positions of $100,000. This can result in significantly higher profits, but also higher losses.
- Margins – Margin is the minimum amount you need in your trading account to be set aside to cover an active trade based on leverage.
- Futures – A futures contract allows a buyer to lock in a price for a future sale of a product so that the seller is assured the sale and the buyer has a fixed price. This is a virtual transaction.
Trading in Commodities
Before you get started you need to find a broker who offers online trading with reliable systems and leverage and margins that suit you. At the same time, do not rely entirely on your broker, but make sure that you have an understanding of the market before you get into a trade. Knowledge is power and will help you make good calls. It is always worthwhile to diversify so that your investment is balanced between commodities. This means that a loss on one commodity will likely be made up for with a profit on another. Because the commodities market is risky, it is also a good idea to diversify your capital so that commodities only take up a portion of your portfolio. At the same time, do not get over-enthusiastic with the leverage and rather stick to one or two good trades each day. Set limits as well as goals. Aim for a constant profit percentage while always sticking to your stop loss levels. This will limit volatility improving your chance of success in the long term. Keep track of all your trades to help you improve your strategy and become even more successful in the future.