How to Get Started Trading Commodities
The commodities markets are made up of thousands of natural goods such as coffee, cocoa, cattle, oil, gold, and natural gas. Commodities include energy resources; livestock; grains, fruits and vegetables; and metals. Trading in commodities might seem like it’s only for the rich or well-connected. A single futures contract for oil is for 1,000 barrels for example. However, traders from all walks of life can get started in the commodities market by opening an account with a registered broker, using a free demo account, and taking online training.
Before you start trading commodities however, it is important to understand the different ways they are traded.
Understanding Commodities Trading
Let’s take a look at the basics so you can get a better idea of what options are available to you.
What Are Commodities?
Commodities are raw materials that are commonly used to make a variety of goods. For example, silver is a popular commodity due to its use in jewelry and a variety of industrial settings. Wheat, a common agricultural commodity, can be used to make bread, pasta, and packaged foods such as muffins and cookies.
The rising and falling prices of commodities are impacted by a variety of factors, including the weather, political unrest, trade agreements, and the economy. In turn, the prices of commodities impact the larger economy by affecting the ultimate prices of consumer goods.
For example, beef prices rose in early 2020 due to the shut down of several processing plants. That, in turn, resulted in higher prices for things like frozen hamburger patties, but also processed foods that use beef.
How Are Commodities Traded?
There are many ways to trade commodities. At its most basic, investors purchase physical commodities. This usually takes the form of direct purchases on a commodities exchange.
There are also commodity derivatives — instruments that allow traders to speculate on commodities without actually owning them. These include futures, options, and swaps. The problem for the beginning trader, however, is that types of contracts normally require large amounts of capital.
Low-Cost Ways to Trade Commodities
One of the most popular options in the UK are contracts for difference (CFDs). These are low-cost contracts traded through regulated brokers like Plus500, eToro.com, and Markets.com.
CFDs provide a way to trade on an underlying asset without you having to own that asset. For example, you can trade CFDs on oil, gold, silver, live cattle, lean hogs, natural gas, and cryptocurrencies.
Profit or loss is based on how much the price of the underlying commodity rises or falls in a specific period of time.
If you predict correctly — meaning you think the price will go up and it does — you earn the difference in price. However, if you predict incorrectly, you have the potential to lose quite a bit.
One of the big pluses of CFDs is you can trade many markets, not just commodities. For example, you can trade CFDs on stocks and ETFs too as well on indices, bonds, and even events.
Note: CFDs originated in London and are not yet legal in the United States.
Getting Started With CFDs
Now that you have a basic understanding of the commodity market, let’s talk about how to get started trading commodities.
Choosing a Broker
The first step to entering the commodities market is to select a broker. The broker you choose can significantly impact your trading experience, so it is important to get this right.
You can find an excellent broker by doing smart online research. Look at factors such as withdrawal fees, types and times of support, mobile trading options, and the educational materials they provide. Many of the top brokers provide their own training materials.
One useful service many brokers provide is a free demo account. This allows you to trade with “monopoly money” or fake money. This is a great way to learn about trading.
Make sure the broker you select is regulated by a government agency that offers customer safeguards such as submitting to regular audits and holding customer funds in a separate account.
What to Trade
In 2020, CFD traders have access to hundreds of assets to trade, including forex (foreign currency exchange rates); cryptocurrencies such as bitcoin; and traditional commodities, such as platinum, natural gas, and cocoa.
Research and Analysis
Most brokers will provide educational information and technical analysis tools you can use to learn more about the markets and specific assets you are interested in trading.
Do not rely on any one type of analysis. Rather, take the time to compare different models to get a complete picture of the market.
Economic calendars, drawing tools, and financial news feeds may also provide critical information you can use to make smart decisions.
Summary: Proceed With Caution
All trading comes with some level of risk. Commodities are no different. Trading CFDs is a particularly risky venture and should not be entered into lightly. Take care to educate yourself about the risks, common types of trading, and the best ways to choose a trustworthy broker.
That said, CFDs have the advantage of allowing you to start trading with little capital so you can limit your risk.