Commodity Trading is the act of buying and selling commodities futures contracts on commodities such as crude oil, gold, silver, platinum, palladium, copper, corn, soybean and more.
A futures contract is a contractual agreement where one party agrees to buy a specified quantity of an asset at a specified price (the futures price) on a specified date (the expiration date).
The opposite side of the contract is sold by another party, who agrees to sell that same quantity at the same price and date.
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What to watch for While Investing in Commodities
1) Moving Average for Trading Commodities
Moving average in commodity trading is one of the trendiest strategies for trading. Investors generally use moving averages to find, analyze the market trend along with the support and resistance level.
Supply and Demand Rule
Supply and demand play an important role in commodity trading. If the demand for any commodity increase, the value of that commodity will definitely increase which in turn increase its price in the commodity market.
But commodity businesses work completely differently. In any individual commodity industry, the product is largely the same. Wheat is wheat, cattle are cattle.
Because of this, producers are all price-takers and in normal times aren't able to dictate prices.
Many commodity trading industries are prime examples of what's called perfectly competitive industries, with many buyers demanding an undifferentiated product and suppliers unable to offer differentiated products.
So what causes prices to fluctuate are imbalances in supply and demand, which may occur for many reasons.
Prices may spike if demand rises or supply becomes constrained.
2) Lowest Cost Wins in Commodities
In commodities, companies are price-takers and compete on price alone. In general, the companies that win here produce at the lowest cost—they generate the most profit per unit and can maintain that profit even if commodity trading prices drop.
The most precarious companies are those that produce at high costs. If prices fall, they won’t be able to produce at a profit and will go out of business if the market doesn’t turn around soon enough.
Of course, if you’re trading the price of the commodity itself, you may be uncertain about any individual producer. However, if supply goes offline, it could help push prices higher.
3) Price spikes are often short-lived
Commodity prices are very volatile. This can be bad news for the companies that produce these commodities: they will sometimes see short-term price spikes or declines that make it impossible to remain profitable.
But this volatility is not permanent, and it is part of the way commodity markets work.
The over-corrections that occur as a result of price volatility are what keep commodity supply and demand in line with one another.
If producers don't respond rapidly to changes in prices, then supply will not increase enough to meet demand, and prices will rise too high for consumers.
Similarly, if producers react too quickly by flooding the market with products, then there will be far more supply than consumers need, which pushes prices down so low that production cannot be cost-effective.
So the swings in commodity prices are often short-lived and represent a "shaking out" of marginal suppliers, those without the capacity or willingness to produce at an efficient rate.
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4) Ways to Invest in Commodities
There are many ways you can invest in commodities. Here are five of the most common:
- Futures, a contract to buy or sell a commodity at a certain price on a certain date in the future
- Physical commodities, the physical goods themselves, such as gold, oil, or wheat
- Exchange-Traded Funds (ETFs), a fund that tracks an index or some other benchmark, which sometimes includes physical commodities
- The stock of commodities producers, the company that provides goods or services that deal with physical commodities, such as mining companies and oil drillers
- ETFs of commodities producers, an ETF that invests in stocks of companies involved in producing goods and services involving physical commodities
Conclusion
So far we have learned about commodities and strategies, and now we will discuss how to invest in commodities.
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