Commodities trading has a lot of similarities to trading in other markets. However, it also has several differences that the inexperienced need to be aware of. Depending on which commodities are being traded, there are often outside factors influencing the market that are not relevant in the wider stock market. Traders also need to be aware that entering futures markets can prove expensive, as there are often high initial margins required to enter into a contract. Commodities trading is a professional interest of Lenn Mayhew Lewis.
One way to make entering the futures markets less cost prohibitive is through Contract for Difference trading. Commodities can also be traded on the options markets, but these have the potential to be highly volatile, particularly binary options. You can learn more about binary options by watching the short video attachment to this post.
Contract for Difference Trading
Contract for Difference trading allows the traders to enter contracts with a much lower initial margin, as they can trade less than the amount required by a full contract. With CFDs, the trader is entering a contract with the broker rather than the seller, where they agree to pay the difference between the price of the commodities between opening and closing the contract. Brokers offering CFDs can therefore offer smaller quantities than standard commodities contract sizes.
In the PDF attachment you can learn more about the use of leverage in Contract for Difference trading.
In the commodity markets, the fundamental factors that underpin each market may be very different to what stocks traders are used to, requiring unique specialist knowledge in various areas, some of which may be quite esoteric or seemingly unrelated to financial markets. For example, trading in agricultural commodities such as crops requires the experienced trader to have knowledge of weather patterns, as process can be driven up or down by adverse weather such as flooding or drought. Traders in precious metals will also need to have knowledge of the currency market, specifically the performance of the US dollar (as this is what most metals are valued in), as well as Federal Reserve interest rates and expectations. Crude oil prices are often affected by strife in the Middle East, requiring a more in-depth knowledge of politics in that region.
Another factor that traders need to consider is the liquidity or illiquidity of the commodity they are thinking of investing in. Some futures markets are highly illiquid and are used by experienced traders not so much for profit, but more for hedging purposes. Retail traders will likely not want to invest heavily in illiquid commodities markets as it can be difficult to exit a position once it has been entered. While entering illiquid markets is not always in and of itself a bad thing, inexperienced traders can end up losing out if they don’t fully understand the markets. Traders who are new to the futures markets may want to consider sticking to the majors such as gold and silver, crude oil and natural gas, and wheat and corn, rather than more exotic products such as lumber or milk.
Some examples of the different categories of commodities that can be traded can be found in the infographic attachment to this post.
Commodities Futures Trading
Commodities across all categories can also be traded on the futures market. In this market, the trader is agreeing to buy or sell a pre-determined amount of a certain commodity at an agreed price on a specified date in the future.