Essential Steps to Begin Commodity Trading Safely
Gold, oil, silver, coffee.. interested in learning more about commodity trading?
Whether it’s through energy commodities such as oil and natural gas or by way of metals like gold and silver, commodity trading provides traders with the opportunity to diversify a portfolio and capitalize on exposure to global markets at large.
However, as with trading in any type of tradeable commodity, that opportunity comes with significant risk.
This guide will walk you through the basics of commodity trading, explore how to implement key strategies, and help you mitigate risk as you dip a toe into one of the largest markets on the planet.
By the end, you’ll understand more about how to approach commodity trading while mitigating risk effectively.
1. What Is Commodity Trading?
Commodity trading refers to the purchasing and selling of either primary products (raw materials) or agricultural products.
There are two main classifications when it comes to commodities:
– Hard Commodities: constitute natural resources extracted or mined (gold, oil, natural gas).
– Soft Commodities: These include agricultural products such as wheat, coffee and corn, which are grown and harvested.
Traders buy and sell these commodities in response to fluctuations in supply, demand and market conditions. Profit opportunities are real, but volatility in price can quickly turn into loses without proper management of risk.
2. How Does Commodity Trading Work?
There are two common ways to engage in commodity trading:
– Spot Trading: buying and selling commodities for immediate delivery. Spot trading is more common in physical markets, but most retail traders prefer futures.
Futures trading: Trading in futures involves entering into an agreement to buy or sell a commodity at a predetermined price at a specified time in the future.
Futures trading allows traders to speculate on the future price movement of a commodity, or it can be used as a strategy to offset potential losses from an adverse price movement in other portfolios such as buying or selling of futures contract.
As futures trading involves price volatility, it carries a high degree of risk and requires prudence on the part of traders.
For example, VPTrade provides access to futures contracts on almost any asset that you can think of. Although futures provide trading opportunities, they can be risky if an asset’s price swings quickly, leading to gains and losses in a short time frame.
3. Why Trade Commodities?
The potential advantages of commodity trading can be outlined as follows:
The flowchart below illustrates the steps involved in commodity trading. It can be clearly seen that the process can be split into 4 main stages.
Overall, there are several risks facing those who want to become involved in commodity trading, but the advantages outweigh these.
– Diversification: Commodities offer an opportunity to diversify beyond stocks and bonds, but volatility can add to the risk a portfolio carries.
Hedge against inflation: many commodities, particularly gold and oil, traditionally perform well when inflation is high. But prices can fall sharply when inflation is low, so keep your wits about you.
-Liquidity: many commodity markets, such as for crude oil and gold, are deep – that is, large numbers of traders are prepared to buy and sell, which makes it easy for you to enter and exit a position. But some markets – especially agricultural products – may be relatively shallow, and liquidity problems may arise at certain times of year.
According to Reuters, in September 2024, ‘Gold prices continued to see-saw on concerns over inflation and shift in central bank policies.’ Gold could shelter those who fear inflation. But anyone trying to buy in when prices are high could be left holding the bag if prices stabilize or fall.
4. Recent Commodity Market Updates: Gold, Oil, and Wheat
According to Reuters, the commodity markets have seen notable activity in recent months:
Gold: It’s August 2024 and gold prices are holding just about steady as central banks around the world rethink their position on inflation.
But the US Federal Reserve’s interest-rate moves in September 2024 put some downward pressure on the yellow metal.
Gold is still seen by many risk-averse traders as a kind of hedge insurance, but traders need to keep their antennae up, as gold prices can move strongly in the opposite direction of prevailing economic sentiment.
– Crude Oil: Oil prices have been particularly volatile in 2024, largely due to geopolitical tension in the Middle East and concerns about supply from OPEC+.
After prices spiked in July 2024 following Saudi Arabia’s decision to extend production cuts, further increases in non-OPEC production have kept prices from rising too high. While volatility in oil can present a good opportunity for trading, sharp swings can charge traders who are unprepared.
– Wheat: Other agricultural commodities such as wheat have also seen price changes in 2024. Wheat, in June 2024, saw price rises due to fears of reduced yields from the crop from the major exporters of wheat, including Russia.
Such price rises offer potential trading opportunities; but also risks, given that the weather and geopolitical events are unpredictable with regards to tobacco crop production.
5. Steps to Start Commodity Trading
To start commodity trading, follow these steps:
Step 1: Choose a Reliable Trading Platform
The first step is selecting a platform with a wide range of commodities, competitive fees, and good tools. If you choose VPTrade, you’ll gain access to all the major commodity markets and advanced charting and risk management tools.
Step 2: Learn the Basics of Commodities
You have to gain an understanding of individual commodities. The price of oil, for example, is driven by geopolitical tensions, and the prices of agricultural commodities such as corn and wheat are driven by the weather.
Step 3: Open a Trading Account
Once you have chosen the platform, you can open a trading account. VPTrade simplifies this path with a user-friendly registration system so that you can start trading in minutes after registration.
Step 4: Choose Your First Commodity
You are just starting out and should concentrate on one or two commodities. Gold and oil are often seen as the markets of choice, being the most liquid and relatively transparent in their pricing. Once you are more experienced, you can start looking at natural gas or agricultural commodities, but remember that the more markets you have a position in, the more the risk increases.
Step 5: Place Your First Trade
Now that you have chosen a commodity, your first trade can be made. On VPTrade, traders can trade both spot contracts and futures. Futures are typically used for speculation on future price movements. As futures are highly volatile, with price movements occurring rapidly throughout the trading day, it is best to use risk management tools such as a stop-loss order when trading futures.
6. Popular Commodities for Beginners
Here are some commodities commonly traded by beginners due to their liquidity and accessibility:
– Gold: This ‘safe haven’ asset is generally regarded as having little volatility, and can be seen as a hedge against any wider market weakness. But prices can also fall, such as when the economy is growing.
– Crude Oil: Oil continues to be one of the most liquid traded commodities in the world. Its price is, however, heavily dictated by geopolitical news and production levels. Volatility creates opportunities but it also requires traders to be on their toes as prices can shift swiftly.
– Natural Gas: A volatile commodity that’s as exciting to trade as it can be dangerous. Fast and significant market movement can result in lucrative dividends or painful losses.
– Commodities: Sometimes referred to as ‘soft commodities’, such as wheat, these are traded on commodities exchanges, which are influenced by a large number of drivers, including weather conditions and global supply chains. They diversify but are also subject to seasonal and geopolitical risks.
Best Trading Practices and Risks Involved
When engaging in commodity trading, following best practices is crucial to mitigating risks:
– Stay Informed and Monitor Global News: Keep up-to-date with global news, and watch for economic developments that could affect commodity prices.
For example, oil prices can rise in response to supply disruptions or geopolitical tensions, and agricultural products such as wheat can increase in price due to low harvests caused by weather conditions.
– Start small: Small trades are helpful in hedging off the highly volatile price swings commodity markets experience.
– Learn as you go: Small trades also mitigate the risk of trading while learning how commodity markets work, which involves a learning curve.
– Risk management: Your broker will offer you the opportunity to sell a commodity if it falls below a certain price level with stop-loss orders. This helps mitigate risk because commodity prices can change quickly.
– Diversify portfolio: spread risk over several commodities. You might choose to combine different metals such as gold with, say, coffee or wheat (assuming that you eat it) to diversify, but also to increase complexity and risk.
7. Risks Involved in Commodity Trading
Commodities trading is associated with a number of risks and traders should be aware of them before getting into the market:
– Volatility of Price: The market is very sensitive to external events. Price can change drastically through shifts in supply and demand, geopolitical tension, and weather. For example, the July 2024 oil price surge followed a decision from the Organization of Petroleum Exporting Countries (OPEC) to cut supply.
– Risk of Leverage: Some platforms, such as VPTrade, offer leverage, which lets you trade with a larger position for smaller initial trades. While leverage can magnify gains, it can also increase losses, so be careful.
– Liquidity Risk: While many commodities in general, and agricultural products such as wheat or coffee in particular, may be relatively illiquid at certain times, this will still prevent you from seizing a good price to make a trade.
VPTrade offers several advantages for both beginner and experienced commodity traders:
– Comprehensive Platform: access to commodity futures on major commodity markets such as oil, gold, or wheat together with advanced charting and risk management functions, are included in VPTrade’s trading platform.
– Risk Management Tools: Stop-loss orders and trailing stops are among the range of tools the basic account holder at VPTrade can use to avoid excessive loss when market conditions are volatile.
– Educational Resources: VPTrade has all the tools you need to learn about the markets you’re trading in, including beginner’s guides and advanced trading strategies.
And although it’s easy to set up and run trades on the VPTrade site, everyone should remember that trading commodities, whatever the actual commodity, involves risk, and that traders should never take on more risk than they can absorb.
Traders using VPTrade should always make use of risk management techniques, such as stop-loss orders, to shield themselves from these dangers.
If traders adhere to these steps – and also use tools like those provided by VPTrade – they feel far more comfortable entering the world of commodity trading.
But although huge gains are a possibility, there are also huge risks, so trading has to be approached cautiously and knowledgeablely.