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How to Trade Commodities

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What is a Commodity?

Commodities are actually physical items that can be handled, stored, and moved about. These are goods for which there is a commercial demand. Commodities include such items as corn, gold, and crude oil. They can be purchased and sold for immediate delivery, known as "spot" delivery, or promised by contract for future delivery. It is these contracts for future delivery that form the basis of the commodities trading market.

What is a Future?

In fact, what is traded in commodities trading markets is what are called futures or futures contracts. These have essentially the same features and effect as the forward delivery contract referred to above, but they are the embodiment of the exchange involved in commodities trading. These are traded in the commodities market through futures exchanges.

Futures contracts serve an important and valuable purpose for purchasers of goods for use in production. A large commercial baker needing a bulk quantity of wheat at a certain time in the future wants to be sure of its availability. To ensure that availability, the maker can enter into a contract for its future delivery with a supplier. Price, quantity, and delivery are guaranteed by the contract, and the purchaser will pay contract price to complete the purchase.This was the history of futures trading in the United States and around the world. Today, however, the purchasers of futures contracts are generally no longer actual users of the commodity, nor do they even intend to take actual delivery of the goods. Instead, these are speculators, purchasing futures contracts for the resale of the contracts themselves, as prices change with changes in supply and demand. Sellers, too, are no longer involved in actual supply or delivery of goods, but instead are simply dealers in futures contracts. Commodities contracts are now forms of investment, and traders in them trade for investment purposes. Futures contracts can still be used to ensure the availability of goods needed for production on a future date, but this has actually become only a secondary function of the market.

Trading in the Commodities Market

The commodities market is vast and open to entry by any investor. Commodities trading is very similar to trading of stocks in how it is performed. An investor wishing to trade commodities will open an account with a commodities broker, will fund the account with a cash deposit, and can then place buy and sell orders in person, by phone, or even possibly over the Internet. Orders are completed quickly, and a purchase will be made in minutes, if not even in seconds.

Commodities trading is different from stock trading in one very important way. Most commodities trades are made on margin, where the trader posts only a fraction of the actual value of the trade in order to complete it. With that fraction, however, the trader owns the full value of the contract, and profits or losses will be based on that full value. This is why commodities trading is so severely risky. Margins are typically only ten to fifteen percent, so that a trader will control one hundred thousand dollars worth of contracts with only a ten thousand dollar investment. The risk of loss, however, is in changes to the contract value, and not just the investment value.

Trading Strategies

There are many commodities trading strategies employed by traders. When deciding on a strategy, consider first your risk tolerance, trading experience, and understanding of the markets. Strategies range from the very simple buy-and-hold strategy, to highly intricate trend trading and range trading. There are systems available, of course, some of which are free, and some of which are for sale only. There are also software platforms for PCs which implement systems and allow for automated management. Some of these cost thousands of dollars.