Commodities trading explained: How to trade commodities

What is commodities trading?

You may be familiar with trading stocks, but what is trading commodities? Commodities trading offers a way to diversify beyond stocks by buying and selling raw materials such as oil and natural gas, base and precious metals, as well as agricultural products, including wheat, coffee and sugar. 

Traders speculate on the future value of a commodity, aiming to benefit from price fluctuations. Note that increased volatility makes commodities risky, as their price can suddenly move against your trade, provoking losses.

Some traders aim to hedge against inflation through commodities trading. Their portfolio holdings might rise in value as prices for goods made from raw materials rise. 

What are commodities?

Today, commodity trading forms the basis of the global trade ecosystem. Energy and metals are essential for manufacturing goods, and agricultural commodities supply the international food markets. They are among the most widely traded goods, and their price movements have global impact.

Commodity market explained

Generally, commodities can be divided into four main categories:

• Agricultural commodities: these include food crops, such as cocoa, cotton, corn and coffee, livestock, like pigs and cattle, and industrial crops, such as palm oil and lumber.

• Energy commodities: these include natural gas, crude oil and gasoline, coal and uranium, ethanol and electricity.

• Metal commodities: cover base metals (copper, iron ore, zinc, aluminium, nickel, steel, etc.) and precious metals (gold, silver, palladium and platinum).

• Environmental commodities: these include renewable energy certificates, carbon emissions and white certificates.

Commodities trading explained

Commodities trading in the past was dominated by multinational conglomerates purchasing raw materials for production as well as major banks and trading houses. But with the advent of online trading, private traders gained access to global commodities markets with relatively modest amounts of capital.

Trading commodities has become a popular means of inflation hedging and portfolio diversification. For many traders and investors, commodity trading is a preferred way to protect funds and reduce the overall risk for their portfolios. 

However, commodities are not immune from drastic price fluctuations. Prices can unexpectedly change direction against your trade, triggering losses.

History of commodities trading

Commodities are some of the oldest forms of financial instruments. The commodities market is almost as old as human civilisation itself. Historical evidence suggests that rice might have been traded around 6,000 years ago. There is evidence that around 4,500 BC, the Sumerians used clay tokens as a form of money to buy livestock.

Trading of commodities, such as spices, metals and oil, has been the driving force behind the rise of empires throughout history, with some developing complex trading systems and means of exchange.

Commodities exchanges were set up in various physical locations around the world to facilitate trade, and the major producing and trading nationals still have their own exchanges. While there are some physical exchanges, most trading is now done electronically.

The largest commodity exchanges include the Chicago Mercantile Exchange (CME), the Intercontinental Exchange (ICE) and the New York Mercantile Exchange (NYMEX) in the US, the London Metal Exchange in the UK, the Tokyo Commodity Exchange in Japan and the Shanghai Futures Exchange in China.

Special characteristics of the commodities market

Commodities traded on international markets tend to share a few common characteristics: 

• Natural resources that most countries or regions need

• Limited geographical sources

• Price volatility

• Standard quality/specifications

Commodities prices are largely driven by the numerous factors that can affect supply and demand such as economic activity, seasonality, weather and geopolitical events. Major disruptions to supply or new sources of production can result in prices spiking or falling heavily.

Major global economic trends and technological advances can change the way that markets trade. For example, the emergence of China as a manufacturing hub has increased demand for energy and metals, and redirected trade flows.

What moves commodities prices?

If you want to start trading commodities, you should become familiar with what moves the commodities market. Supply and demand determine the direction of prices. If the supply of a commodity such as copper increases, the price decreases; and if supply falls, the price rises. 

Let’s look at some of the factors that affect supply and demand, causing commodity trading prices to fluctuate.

Physical consumption

Use of commodities among manufacturers and other consumers is one of the primary drivers for prices. For example, if buyers are looking to purchase larger quantities of aluminium and supply is stable or low, they will have to pay more. Conversely, if demand falls and there is more aluminium available on the market, sellers will reduce their prices to attract buyers.

Production changes

Fluctuations in supply have a major impact on commodity markets. If mines have to reduce their output, crops fail or oil producers decide to pump less, supply will decrease and prices will rise. On the other hand, if a new mine, plantation or oil field starts production, there will be increased supply on the market and prices will fall if there is not enough demand to balance it.

Currency movements

Most commodities markets are denominated in US dollars, so the value of the US currency has an impact on prices. If the dollar rises against other currencies, commodities become more expensive for buyers that have to convert their currencies into dollars, which can reduce demand. When the dollar falls, commodities become cheaper for overseas buyers and increases demand. 

Geopolitical environment

The production of commodities is typically concentrated in certain countries or regions. Political developments can affect supply. For example, the trade war between the US and China in 2018 affected supply and demand for commodities. Western sanctions on Iran have reduced the supply of crude oil. And the Russian invasion of Ukraine has disrupted the supply of grain on the global market.

Economic activity

The rate of economic growth in a country drives its demand for raw materials and other commodities. As an economy grows, the purchasing power of the population increases and demand for products and services rises. 

The emergence of China and India as major engines of growth has increased their demand for commodities. But when a country enters a recession, economic activity contracts and demand for commodities falls.

Transportation and storage

The cost of shipping, rail and truck freight can affect commodity prices. In addition, disruptions to transportation, for example due to bad weather or drivers’ strikes, can lift commodity prices at the intended destination. It can also reduce prices if traders attempt to sell the commodity locally instead. 

On the crude oil market, tankers are used as floating storage when there is oversupply as traders wait for prices to rise. This reduces the availability of tankers and increases shipping rates.

Weather

Adverse weather conditions can have an impact on a range of commodities. It can damage harvests, disrupt oil and gas production and hamper mining activity, as well as causing logistics problems. Cold weather can increase demand for energy, lifting prices. Conversely good weather can yield bumper crops, resulting in an oversupply of agricultural commodities.

Seasonality

There are seasonal factors that affect both demand and supply. Demand for some commodities is seasonal, with energy demand rising during the winter and falling during the summer. 

Demand for metals used in jewellery can increase during festival and wedding seasons in some countries. And the supply of agricultural products can depend on when crops are harvested.

How to trade commodities

Are you interested in how to trade commodities? Commodities are most commonly traded on futures exchanges, allowing traders to speculate on future prices.

Commodities buyers, such as manufacturing companies, also make physical purchases to take delivery. As a trader, there are several different ways you can use commodities, depending on your experience and preferred approach.

CFD trading

One of the popular ways to trade commodity markets is with contracts for difference (CFDs). A CFD is a type of contract between a trader and a broker that allows the latter to speculate on the price difference between opening and closing the trade. 

When trading commodity CFDs you do not own the underlying asset, but only speculate on its price fluctuations. Therefore, trading CFDs does not involve paying extra fees for storage, which is the case with physical commodity delivery. Using CFDs to trade commodities will allow you to go long or short without having to deal with conventional commodities exchanges, such as CME, ICE or NYMEX.

There are crucial differences between buying commodities and trading commodity CFDs. Due to overnight charges, necessary for position maintenance, CFDs are not typically used as long-term investments. 

Note that CFD trading is risky. Contracts for difference are leveraged products, meaning your potential profits can be magnified, but if the market goes against your position, so too are your losses.

Commodities futures

If you have an account with a brokerage that offers futures, you can buy and sell contracts from a futures exchange. By trading commodity futures, you enter an agreement with another investor based on the price you expect a commodity to trade at on a specified date.

Commodity options 

Commodity options are derivatives based on futures contracts for the underlying asset. Options contracts give the holder the right to buy or sell the underlying commodity at a specified price (known as a strike price) on a set date in the future. You make a profit if the price moves toward the strike price by the expiry date, or lose the money paid for the contract if the price moves against the position.

Physical commodity purchases

Speculating on a price with derivatives may be a preferred way to trade a commodity for retail investors, as you hardly want to take physical delivery. But if you do want to own a physical asset, like gold bullion or an oil barrel, you can buy it from a dealer and have it stored securely.

Commodities stocks

What are commodities stocks? An alternative to speculating directly on the price for a commodity is to trade the stock of a company involved in the sector. 

For example, you could invest in the stock of an oil refiner or copper miner, as the share price may respond to movements in the underlying commodity price. 

You should keep in mind that company stocks do not track commodity prices directly, and the share price can also go against your expectations, triggering losses, as stocks are affected by other factors such as the company management’s strategy and fundamentals.  

Commodities ETFs

For traders looking to gain broader market exposure, there are exchange traded funds (ETFs) and exchange traded notes (ETNs) that pool money from investors to build portfolios that track the price of a single commodity or a basket of commodities. 

ETFs can buy futures contracts or invest in commodity company stocks. They may offer instant access to a diversified range of assets, which could take a longer time to build for yourself. However, ETFs incur management fees and, depending on their composition, may not provide the same returns as the asset it is supposed to track.

Commodity pools and managed futures

There are private funds that invest in commodities but unlike mutual funds they are not publicly traded, so you must be approved to buy into them. Commodity pools and managed futures funds can use more complex trading strategies and offer the potential for higher returns than ETFs and other funds, although management fees are typically higher as a result.

What is a commodities trading strategy?

Before you get started, it is important to determine the commodity trading strategy you will use to open, manage and close your positions and minimise the risk of losses. 

There are several different strategies for commodity trading you can employ depending on your experience, risk tolerance and preferred approach. Most commodity strategies use technical analysis along with following market fundamentals to decide when to buy and sell.

Technical strategy

Technical analysis uses a range of chart indicators to track price movements, identify patterns and give buy and sell signals. Technical indicators form the basis for most trading strategies as they identify patterns in pricing that traders can decide to use in different ways. Each strategy has its own way of incorporating technical indicators.

Price action trading

A strategy focused on price action tracks the historical price movement of a commodity to predict how it could trade in the future. Commodity markets tend to be highly liquid, giving traders the chance to respond quickly to price volatility. 

Price action trading is well suited to quick decision making as traders do not need to wait for signals from technical indicators that can lag behind price movements.

Trend trading

Trend trading is also referred to as position trading and takes a longer-term approach that could last months. Trend traders attempt to speculate on the directional trends in a commodity price. They enter a long position when a price is in an upward trend and go short when a price is in a downward trend. 

Trend traders tend to look at fundamental factors more than technical indicators, as the trend could take time to play out. Trend traders are always on the lookout for a trend reversal to determine when to exit their position.

News trading

A news trading strategy focuses on following news events that can have an impact on commodity prices. These can include everything from extreme weather to geopolitical developments. 

A news trading strategy would have bought commodities such as oil, metals, or grains at the start of Russia’s invasion of Ukraine and sold when prices rallied on concerns about the impact on supply. A news trading strategy would also buy commodities on news of a storm or other bad weather conditions affecting crop or mining output. 

Position trading strategy

Also referred to as trend trading, position trading focuses on long-term price trends rather than short-term volatility.

Range trading

A range trading strategy identifies the support and resistance levels that the price establishes, typically using technical analysis indicators like Bollinger Bands or other charting tools. Range traders buy when prices are close to the support level at the bottom of a range and sell when prices approach resistance at the top of a range. 

In a commodity market, the support and resistance levels are strongly influenced by supply and demand, as strong demand or tight supply pushes prices to their peak until buyers are unable to pay more and prices pull back. It is important for traders to identify when a commodity is reaching oversold territory as it suggests the commodity is undervalued and the price is set to rebound.

Breakout trading

A breakout trading strategy is focused on short-term price movements. Traders look to profit from a commodity breaking out of its recent trading range, buying before the price moves higher or selling before it drops lower. 

Breakout trading strategies can be used along with range trading when a price moves below support or above resistance, but they are not limited to those levels, as breakouts can happen at any time.

Fundamental trading

Fundamental trading focuses on analysing market fundamentals that affect supply and demand, rather than just technical indicators to predict price movements. 

For example, a commodities trader observing a prolonged drought period in Latin America might buy agricultural commodities in expectation of a smaller harvest reducing supply. Or strong economic growth in China might direct a trader to trade industrial metals in anticipation of strong demand. Conversely, a fundamental crude oil trading strategy might prompt a trader to short crude oil in response to signs of a recession reducing demand.

Pros and cons of trading commodities CFDs

CFDs allow you to speculate on the price of commodities without having to take physical delivery or worry about storage costs for assets such as gold or silver bullion. Unlike futures contracts, CFDs do not have a specified expiry date, giving you flexibility as to when you close your position. Note that contracts for difference are considered short-term investments due to overnight fees.

CFDs also provide the option to trade commodities in both directions. Whether you have a positive or negative view of the commodity price forecast, you can speculate on upward or downward future price movements.

Another feature of a CFD is that it is a leveraged product. Leverage makes it highly risky as it may increase losses and profits. For example, a 10% margin (the number may vary depending on the commodity and the CFD broker) offered by Capital.com means you should deposit only 10% of the total value of the trade you want to open. The rest is covered by your CFD provider. 

In this case, if you want to place a trade for, let’s say, $1,000 worth of a particular commodity CFD, and your broker requires a 10% margin, you should spend only $100 to open the trade. 

However, you should also be aware that CFD trading carries risks as CFDs are leveraged products that use margin. This means they not only increase gains if the price moves in the same direction as your position but also increase the size of losses if the price moves against your position. It is very important to do your own research to understand how leverage and margin work before you start trading CFDs.

Why trade commodities with Capital.com

Advanced AI technology at its core: A personalised news feed provides users with unique content depending on their preferences. The neural network analyses in-app behaviour and suggests videos and articles that fit your investment strategy. This will help you to refine your approach when you trade commodity CFDs.

Trading on margin: Thanks to margin trading, Capital.com allows you to trade commodity CFDs, and other top-traded assets, even with a limited amount of funds in your account. Keep in mind that CFDs are leveraged products, which means both profits and losses can be magnified. 

Trading the difference: By trading commodity CFDs, you don’t buy the underlying asset itself. You only speculate on the rise or fall of the particular commodity. A CFD trader can go short or long, set stop loss, guaranteed stop loss and limit orders and apply trading scenarios that align with his or her objectives. CFD trading is similar to traditional trading in terms of its associated strategies. However, CFD trading is short term in nature, due to overnight charges. Plus, there are extra risks associated with leverage as it can magnify both profits and losses.

All-round trading analysis: The browser-based platform allows traders to shape their own market analysis and make forecasts with sleek technical indicators. Capital.com provides live market updates and various chart formats, available on desktop, iOS and Android.

Sign up at Capital.com and use our web platform or download the trading app to trade CFDs on the go. It will take you just three minutes to open an account and view the world’s most traded markets.

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Commodities trading hours

If you want to start trading commodities you should be aware of the standard commodity market timing so you know when you can open and close trades. 

On most exchanges, commodities trading hours are between 09:00 and 23:30 local time on weekdays. Exchanges close on weekends and public holidays. Exchanges typically publish calendars each year listing the dates they are closed for holidays are any other reasons so traders are aware in advance of any changes to the usual commodities trading time.

At Capital.com, commodity CFDs are available for trading on:

• Monday to Wednesday: 00:00 - 21:00; 22:05 - 00:00

• Thursday: 00:00 - 21:00

You can always check the trading hours for a particular commodity on a dedicated market page at our website or on the platform.

When is the best time to trade commodities?

There is no best time to trade commodities. The preferred time of day to trade varies by commodity and exchange, and by traders’ circumstances. There are some examples of the most active commodity trading times when volumes tend to be higher. 

West Texas Intermediate (WTI) crude oil contracts, the benchmark for the US oil market, tend to be most liquid during 09:00 to 14:30 EST. Prices for agricultural products tend to move on the release of World Agricultural Supply and Demand Estimates (WASDE) reports which contain data on supply and demand expectations. The gold market tends to be most active at the London open at 08:00 GMT and the US market open at 13:30 GMT as traders tend to place orders at the opening bell.

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