Commodities are of high economic importance and this is just as true today as it was thousands of years ago. It is therefore not surprising that trading in commodities is a popular investment strategy.
Trading in commodities involves taking an opinion as to whether the price of a specific commodity is going to rise or fall and placing a bet accordingly on this anticipated outcome.
Commodities trading is not for the novice investor as price swings can quickly move against you as well as going in your favor, which means that you can quickly lose a large amount of amount, or bank a handsome profit.
Commodity trading takes place mainly in four specific categories, with individual markets within those categories.
These are –
- Livestock and Meat
Trading in energy prices could involve crude oil, natural gas and gasoline prices. Metals include gold, silver, platinum and copper. Livestock and Meat covers markets that trade live cattle, pork bellies and different types of livestock in the food chain. Agricultural trading can involve speculating on the price of corn, wheat, rice, cotton and sugar.
It is normal for a commodities trader to specialise in a particular sector or market where they have good industry knowledge or want to take a position on how the markets will react to certain events or conditions, such as poor weather spoiling crops or political instability threatening supply, which may push the price up.
It is important to note that one of the investment characteristics of commodity trading is that agreed-upon standards are often required.
What this means is that as it would not be feasible to inspect the quality of the livestock you are buying with a visual inspection, or check the quality of the wheat crop you are purchasing, agreed-upon standards allow trades to be executed on the understanding that the commodity is of an acceptable standard that the buyer would expect.
You can use commodities trading to hedge against a position you have in the stock market, such as by trading in precious metals and effectively trying to recover a losing situation. Caution is advised although when you learn how commodities trading works, you will will find some plays are more sensible than others and you can moderate your trading according to your risk-profile to a certain extent.
Sound advice would be to allocate a maximum of 10% of your investment portfolio to commodities as these trades can soon escalate into risky investments when they are affected by scenarios that are sometimes difficult to predict.
If you would like to know how to trade commodities, the first step is to open an online trading account with a brokerage of your choice.
Once you have completed the application form and your account has been approved, you can start to trade commodities through your online broker. The way you do this is through future contracts, which are agreements that involve the seller delivering the commodity to the buyer on a pre-determined date.
You can also buy commodities through ETF’s, which you do by purchasing shares of the chosen ETF.
The fundamental difference with this method is that you are entrusting the purchasing decisions to the investment management team of the fund in question.
The other way to get involved in commodities is to obtain exposure to them through mutual funds.
Mutual funds differ to ETF’s in that their portfolios will be more diverse and not just consist of commodities but other securities as well.