Trading commodities is the practice of buying and selling of products which are either extracted from the ground (crude oil, gold, silver, platinum) or are derivatives of products extracted from the ground (natural gas).
The definition also includes the trading of agricultural products of economic value (corn, wheat, coffee) or derivatives of such products (sugar). The principle behind commodity trading is the same principle behind the trading of currencies, stocks and other financial instruments, which is the change in the perceived value of the commodity in question on a day to day basis. This change in value is a function of the perception of value by farmers, dealers, traders, and market speculators. It is the way a commodity is perceived by market participants in terms of value that determines the demand placed on the commodity and consequently its price.
How commodity trading is done
Commodities are traded on a spot and futures basis.
On the spot commodities market, the commodity is bought or sold without physical exchange of the commodity, and traders can buy or sell a commodity and profit from price differences on the spot commodity platforms. Many forex brokers now add commodity instruments to their basket of assets, making it easier for traders to trade spot contracts on them.
Trading commodity futures will involve trading options contracts on them with or without the physical exchange of the commodity involved. Commodity futures are actually the form in which commodity contracts were traded in centuries gone by. The concept behind futures trading was to standardize the exchange prices, quantity and quality of the commodities, since many of them (especially the agricultural commodities) were perishable and subject to many vagaries. A farmer who wanted to be sure of getting a particular price for his products as a hedge against price fluctuations would enter into a contract with a dealer to receive a particular payment price for his products in exchange for a particular quantity of the commodity. A dealer who wanted to be sure of receiving a particular quantity and standard of a commodity product without fear of paying excessive prices due to inflation or natural disaster would enter into a commodity futures contract with a farmer. Either way, the essence of the futures contract was to give benefit to both parties so no one was cheated.
Commodities can also be traded on the binary options market and as Exchange Traded Funds (ETF) on the American Exchange (AMEX).
Commodity trading is done on the exchange of the Chicago Board of Trade (CBOT), on ICE (energy futures such as natural gas futures) and on the floor of the New York Mercantile Exchange (crude oil)
Just like in forex trading, it is the job of the commodity broker to match the buyers of a commodity to the sellers of that commodity. All buy and sell orders are matched by brokers.
The liquidity requirements in commodity trading are much higher than in forex, so traders need a lot of capital to trade commodities. The forex brokers who now offer commodities as part of their underlying assets now provide much smaller contracts for traders. Price movements in the commodity market are in the region of 0.25 to 0.5 pips per tick depending on if the contract size is a full contract or a mini contract. With such a large sized contract, traders are provided with leverage by the brokers.
Procedures for trading commodities
The first step is to get a commodities trading account with a broker. The trader is expected to fill an account opening form online, submit a proof of address (utility bill or bank account statement) and proof of identity (national ID card or international passport) and fund the account after activation. Many forex brokers now offer trading in gold, silver and crude oil, as these are the most traded commodities. Other brokers like Interactive Brokers offer full and mini contracts straight as they are priced by the commodities exchange.
Traders can trade the virtual platforms, or trade through their brokers using the open outcry system on the floor of the commodities exchange in Chicago. Through options brokers, traders can also trade options on commodity futures. There is also the opportunity to trade commodity swaps. When it comes to trading commodities, there is something for everyone to trade; beginners can try out commodity binary options while more experienced traders can trade the options and futures contracts.