Before you start trading commodities, it is important to understand just what commodities actually are. Commodities are products such as platinum, silver, gold, or oil that are first found in the ground and then extracted. Products such as petroleum or natural gas that are derivatives of these basic materials are also considered to be commodities.
In addition to the raw materials that are extracted from the earth, the definition also includes agricultural products such as coffee, wheat, and corn that are grown in the earth as well as products such as sugar that are directly derived from these agricultural products. Commodities trading is similar in some sense to the trading of financial instruments such as stocks and currencies. Both versions operate on the principal that the perceived value of commodities changes on a daily basis.
The most important players in this particular market are the market speculators, traders, dealers, and the farmers and miners involved in producing and extracting raw foods and materials. These participants in the market determine how much demand there is for a particular type of item. That demand affects the price of it.
What Do Commodity Traders Do?
There are two basis for commodity trading: spot and futures.
Traders don’t actually take possession of the commodity in the spot commodity market. Instead, they buy and sell when they locate different prices on the various spot commodity platforms hoping to make a profit on the price differences. To make it simpler for traders to conduct spot contracts, Forex brokers are increasingly including instruments for the commodity trading on their trading sites.
Unlike spot trading, products may or may not be taken possession of when trading is conducted in commodities futures. Options contracts are what is traded. This practice has a long history and has been around for hundreds of years.
The reason that this trading practice has persisted is because it worked to make prices more standard within a region. Price stability is important since many of the agricultural products are perishable and subject to many unforeseeable circumstances.
To ensure that he would be able to sell his product in a timely manner, a farmer entered into a contract at a particular price point with a dealer. In turn, the dealer was assured of getting the type, quality, and quantity of product that he wanted wanted without being subject to natural disasters or inflation that might drive the price up in the future. These so-called futures contracts benefited both parties in the transaction.
People who trade commodities may also do so as Exchange Traded Funds (ETF) on the American Exchange (AMEX) or on the binary options market.
Crude oil is traded on the floor of the New York Mercantile Exchange. Natural gas is traded as an energy future. This and other energy futures are traded on ICE. The Chicago Board of Trade (CBOT) is responsible for much of the commodity trading in the US.
Brokers are active in this sector, just like they are in the world of Forex trading. Their job is to find sellers for commodities for buyers. Brokers match all buy and sell orders in this market.
Traders must have access to a great deal of capital in order to be successful in commodity trading because the liquidity requirements are higher. Because of this, Forex brokers who have moved into commodity trading provide their traders with smaller contracts. Depending upon whether or not the size is a mini or a full contract, price movements range from 0.25 to 0.5 pips/tick. When brokers provide large contracts like this, traders gain leverage.
Commodity Trading Procedures
To start trading commodities, an account with a broker must be obtained. The trader must provide proof of identity and of address, fill out a form, and fund the account after it has been activated. Since crude oil, silver, and gold are the most frequently traded commodities, they are the ones chosen by many Forex brokers to offer to their traders. Interactive Brokers has chosen to offer both mini and full contracts.
There are virtual platforms to trade on in addition to the open outcry system at the CBOT that brokers attend on behalf of their clients. To trade options on futures, traders must work with options brokers. Commodity swaps are another option. There is a great deal of variety in this market. Binary options trading is a good choice for beginners. Futures contracts are best done after experience has been gained.