How to Trade Commodities Online?
What is a Commodity?
A commodity is a physical product that can be bought and sold in a financial exchange. However traders can also trade commodities on a CFD trading platform. Commodities can be divided into four main categories: precious metals like Gold for example, not precious metals, energy and agricultural. Some of the most popular commodities are:
- Metals (Precious and not precious) like Gold and Silver
- Energy – crude oil and natural gas
- Agricultural – like corn, milk and cocoa
How can you trade commodities?
Commodities are normally traded on the futures market with futures contracts. Those are basically some short term contract that have a definite expire date. In a commodity futures contract the seller will agree to deliver an agreed quantity of a commodity in a date in the future at a determined price. The buyer will accept to buy the product and will make the payment agreed at the specified date.
The futures market is the exchange that connects sellers of a particular commodity with the buyers. So if anyone is looking to trade in commodities it can buy a futures contract via a commodities broker. The contract can only be made after a minimum deposit has been paid. Considering that commodity prices are always moving the value of the brokerage account will also change during the contractual period. If the value however goes below a certain level the broker will make a margin call and it will ask the account holder to pay in additional funds into the account to keep that position open. Normally those accounts are highly leveraged which means that even the small change in price will result in a massive profit or loss. This is one of the main reason why lots of traders are trading in commodities.
Commodities however can also be traded indirectly with an equity market: they can be traded through exchange-traded funds (ETFs) or through a contract for difference (CFD). Unless you are a manufacturers you don’t want the actual delivery of the commodity you are trading. For this reason a commodity trader normally opt to roll-over the futures contract for that commodity. When there is a commodity roll-over basically it extends the expiration date for the settlement of the contract and allows the trader to avoid the cossts associated with the settlement of an expire futures contract.
How can you trade commodities with CFDs and what is the leverage?
Trading commodities is becoming a very popular choice because it normally offers very high potentials of quick profits (but also increased chances of making a huge loss). This means that the trader can start speculating already with a small deposit: if the price will move in the direction hoped, he can make multiples of his investment. The opposite however is also true which means that if the commodity market moves against the trader the losses can be very significants.
What the broker does is that lends the trader the remaining portion of the actual commodity value and this is normally charged an overnight financing charge. For example if you look at CFD broker CMC Markets they are charging an overnight fee + / – 2.5% annual charge above or below the relevant base rate. To better understand this charge you can assume that you buy a commodities futures contract for gold where the cost per ounce of gold is $1,000,000. You decide to sign 2 contracts at a weight of 100 ounces per contract. The full contract will therefore cost $1,000 x 2 x 100 = $200,000. In this case you will make a margin deposit of 6% which is the equivalent of 0.06 x 1,000 x 2 x 100 = $12,000. In this example the broker is basically lending you the difference which is $188,000. If the price of goal increases to $1010 per ounce your profit will be $1010 x 200 – 200,000 = $2,000 and the return will be (2000/12000) 16.67%.
So in this particular example with an account balance of $12,000 you would have made a profit of $2,000 (16.67%) just with a small 1% price increase. This sounds great but on the same hand it is important to note that if the price had fallen by the same figure, you would have made a loss of 16.67%. So trading in commodities carries huge potentials but also huge risks.
Why more and more traders are choosing to trade commodities with CFDs?
One of the main reason is that the leverage and smaller contract sizes are attracting traders to tracing futures contracts as CFDs (contract for difference) instead than traditional trading. The main reason is that with a combination of smaller contracts and leverage the capital required to start trading is significantly lower.