The Ultimate Starter’s Guide to Commodity Trading

The Ultimate Starter’s Guide to Commodity Trading

Commodity trading is one of the areas in the financial world that has risen in popularity in recent years. It has gained more interest among investors looking for alternative trading instruments from stocks and bonds.

The word Commodities with coffee, rice, corn and graph

If you’re thinking of entering field of commodities, then you need to first understand the basics. We’ll be discussing the essentials of commodity trading: what it is, how it’s done, and the strategies you can use.

What is Commodity Trading?

At its core, commodity trading is pretty simple. It’s the process of moving the raw materials needed for everyday life. Taking these materials from their place of production or extraction and transferring them to their place of consumption.

Commodity trading is part of a diverse industry. The commodity value chain is considerably long and complex. It involves various actors across the world. Traders are considered to be the organizer of the chain seeing as they send the commodities as efficiently as possible to the place where they are highest in demand. They make sure that there will only be the best outcomes for consumers and producers.

As a commodity trader, your focus will mainly be on investing in physical substances such as oil and gold. You’ll most often find yourself dealing in raw materials used at the beginning of the production value chain. This includes copper for construction or grains for animal feed.

They aren’t limited to just these commodities. Commodity traders can trade goods as diverse as cocoa, coffee, cereals, sugar, natural gas, and other precious metals.

The commodity traders are responsible for matching the supply and demand in the most cost-effective ways. It’s important to note that commodities are not always readily available where the demand lies. Therefore, as a commodity trader, you’ll have to make sure that the supply makes it safely to meet the demand elsewhere. This can be done by organizing commodity supply chains.

Commodities being traded are commonly goods of value, consistent in quality, and produced in large volumes by various suppliers. Since supply and demand directly affect the trading, limited supply can cause the price to increase. Having excess supply on the other hand can sue a decrease in price.

How to Trade Commodities

Nowadays, you can easily trade commodities online. There isn’t that much steps involved in the process. Regardless, that doesn’t mean that it’s an activity you should pursue immediately without doing lots of homework. Merely conducting the traditional method of calling a commodity broker to place orders and waiting for a call back for a filled order price is no longer as efficient as online trading. You should keep in mind that if you wish to trade commodities online, you should keep in mind some of these important factors.

Girl trading commodities on her computer

Choosing Your Commodity Broker

The very first thing you need to do is to pick a commodity broker. Almost all commodity traders today offer online trading, but there are still those who specialize in online trading.

Keep in mind that what you’re looking for is a person or organization that can help you achieve your goal. There are numerous online brokers that offer excellent products, great service, and low commission rates. Consider them all wisely before signing up with just anyone.

Paperwork Accompanying Your Commodities Account

Before securing your own commodity account, commodity brokers will usually require you to submit documentation. The forms will prompt you to disclose financial information as well as identify the risks involved in trading commodities.

It is extremely crucial for you to disclose financial data since commodities are highly leveraged assets. Since the leverage is high, you stand to lose more money than what you initially invested. The brokers are simply making sure that you’ll be able to survive any possible negative outcomes.

The information normally required by brokers are those regarding income, net worth, and credit worthiness. But not all those who complete the account forms are deemed suitable to open a commodities account. Brokers may use discretion in determining whether an investor is suitable or not. Critical elements that help determine the suitability are having sufficient income, trading experience, and credit.

Funding Your Account

After accomplishing the two precious steps, you now need to fund your account. It’s up to you to decide the amount of funding or account size when you first open an account. Your comfort level and risk tolerance are important factors that you should consider before deciding.

Remember that having a well-researched trading plan is important before trading with actual money. There are numerous commodity brokers that offer simulations for you to practice with before putting your capital to work.

With the right training and simulation, you can familiarize yourself with placing orders. This can also prevent you from making critical order entry errors while helping develop a coherent and efficient plan for approaching markets.

Never Neglect Due Diligence

Always remember to do your homework when it comes to any kind of venture. Make you sure you understand the ins-and-outs of the markets you decide to trade in before making any final decisions.

Myths about Commodity Trading infographic

Common Myths about Commodity Trading

Here are eight myths about commodity trading that you might have heard during your time in the financial markets.

1.      You can’t be sure of the quality of the delivered commodities

Most exchanges across the globe set up quality control measures. This is to help make sure that the commodities delivered to their warehouses will meet high quality standards. They also make efforts in ensuring that only the quality stocks are delivered to the buyers.

According to experts, if commodities are delivered within the final validity period, they are considered to be of standard grade and quality.

2.      Commodity trading can only be done by large traders and high net worth investors

Commodities experts point out that it’s the same as any other derivatives market. They say that anyone can trade small percentage of the total value of the contract by simply paying for it.

The big exchanges include the Multi Commodity Exchange, the National Commodity and Derivatives Exchange, the National Multi Commodity Exchange, and the Indian Commodity Exchange. These exchanges offer several options for diverse set of people. They cater to high net worth investors, companies, and small investors alike.

3.      Conducting commodity exchanges will fuel inflation

Commodity exchanges actually promote price transparency. You can easily view the live international price of various commodities anywhere in the world through your trading terminal.

4.      It’s compulsory to deliver commodities

People think that anyone who buys commodity derivatives must take delivery as well. But that is not the case for everybody. Delivery is only mandatory in specific commodities, which only happens if the position is kept open after the delivery notice period.

5.      Prices of commodities can easily be manipulated

You should keep in mind that most of the commodities being traded are produced and consumed by people across the globe. Considering this, it will not be easy for an individual or a group of people to manipulate the prices. However, experts say that illiquid commodities can be easily manipulated.

Man standing over table and studying printed data

6.      Understanding the commodity market can prove to be too difficult

Most of the investors share the thought that the commodity market is hard to understand. Experts beg to differ. They say that commodities are easier to understand. This can be proven since it involves basic economic factors and seasonal cycles which are what affect the prices.

They also point out that all commodities are globally traded. Information about the global demand-supply situation can be easily accessed by anyone who would want to know about it.

7.      Commodity markets are too volatile

A lot of commodity investors see volatility as a big problem. This problem mostly arises during times when investors decide to overtrade and use the margin to the hilt. This only shows that most investors do not know how to gain from the high leverage that accompanies commodity trading.

When investors decide to use the margin up to the hilt, they can double their money if the prices rise a little. Nevertheless, if the prices fall, they stand to lose all of their money.

8.      It’s too difficult to make money in commodity trading

Most of the investors believe that a lot of investors lose money in commodities futures. But experts say that, like with other markets, this only happens when the participants do not trade with discipline. They then mostly succumb to greed and fear.

This is particularly obvious when investors hold onto losses in expectation that prices will recover.]

Conclusion

Commodity trading can be fairly easy to do. You just need to be well-informed before entering trades. Make sure that you have learned as much as you can with regards to the market before making final decisions.

Also, always keep in mind that you should avoid overtrading. Choose all your trade wisely. This way, you’ll be able to prevent yourself from taking up too many trades all at once.

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