What does it mean to trade commodities?
Commodities are interchangeable basic goods that are essentially the raw materials of an economy. Hard commodities can be extracted or mined, such as precious metals, whereas soft commodities are grown, such as crops or livestock.
Due to the fact that commodities are the building blocks of any economy, price fluctuations can have a huge effect on the subsequent prices of goods within it – whether this be rising crude oil prices rendering petrol more expensive or crop prices falling, leaving basic foods cheaper.
Commodities also play a crucial role for traders and investors. Commodities are used as a trading and investment tool to diversify holdings and store value during particularly volatile markets or short bear dips. For instance, gold is sometimes considered a hedge against inflation or a store of value in times of economic crisis.
Commodity traders buy, sell and so exchange commodities with one another. Traditionally, the average trader or investor would not involve themselves in these markets due to the amount of time, money and expertise they demanded. However, there are now more accessible ways to gain exposure in the commodities market.
History of commodity trading
The exchanging of commodities is a phenomena that predates the birth of stock and bond trading. Commodity trading has always been an essential part of trade. Merchants – the term historically coined to commodity traders who trade these goods on the behalf of the producer – have existed for as long as industry, trade and commerce have.
Ancient civilisations, through the medium of merchants, could participate in commodity trading long before the conception of the modern-day conventional market. Merchant trading eventually gave rise to exchanges as they are seen today.
The Royal Exchange in London was founded in 1571 by a merchant in order to establish a centre for commerce in the capital. This institution later led to the creation of commodity trading companies such as the London Metal Market and Exchange Company, which later established the London Metal Exchange – the destination for the trading of precious metals. Other notable exchanges include the Chicago Mercantile Exchange, which is a US commodities derivatives exchange that offers agricultural commodity trading.
Types of commodities
Commodities are broadly split into two categories: hard and soft. Hard commodities are those that need to be extracted or mined. Examples include: gas, oil, precious metals and rubber. Alternatively, soft commodities are those that are grown, such as livestock, crops or produce. Hard commodities can be further divided into two groups: 1. Metals, like gold, silver or copper; and 2. energy, like crude oil or natural gas. Soft commodities can also be split into two more refined groups: 1. livestock, such as live cattles or lean hog; and 2. agricultural, such as cocoa, coffee and soya beans.
Overview of how to invest in commodities
Investing in the actual asset. The most direct way to trade a commodity is to literally purchase that commodity itself. This is a relatively illiquid way to invest in the commodities market, though commodities can also be a hassle to physically store.
Investing in exchange-traded funds (ETFs). Commodity-based ETFs are one way to gain exposure to commodities.
Investing in a contract for difference (CFD). You can trade CFDs on commodities where you can amplify your trading value using leverage whilst making your earnings exempt from stamp duty.
Start trading commodities online now at Capital.com.
Read more about commodities trading:
- Commodity trading: an introduction to the commodities market
- How to invest in commodities
- What is commodity trading?
- How to trade commodities