Commodity Trading - A Brief Overview | Investing

Commodity Trading - A Brief Overview

25 May.

Commodity Trading is strictly speaking the trading of physical commodities - such as soyabeans, wheat, corn, gold, silver, cattle, oil etc. - or their futures contracts on the established commodity exchanges.

Farmers use commodity trading to lock in favorable prices prior to an ensuing harvest. Hence, there are real commercial reasons for trading in commodities. However, they are also traded for pure speculation by private traders seeking to make a commodity trading profit by speculating in the price movement over their chosen time-frame.

More than any other type of speculation, such as forex or stock trading, commodity markets involve a very high degree of seasonality. Hence, it is important that the trader be very aware of the underlying cycles affecting the market in question.

That said, commodity trading can be done successfully by giving a very high degree of emphasis to the price charts alone. The commodities trade extremely well according to technical analysis methods. For example, Fibonacci price retracements and time cycle analysis work extremely well on commodity charts. So too do other technical indicators such as moving averages, price gaps, support and resistance points, trendlines and so on.

Trading commodities can be an extremely volatile and unpredictable business because these markets are known for their sudden and sustained price surges and collapses. Compare a long-term commodity chart of something like soybeans or oil to any stock index and you will see the difference. Hence, it is vital in commodity trading that you are extremely disciplined in your approach and employ strict money management rules. A good stop loss order, placed in the market at the time you place your trade, is a must.

Traders also play the spreads between commodities, which is an extremely popular form of commodity trading, and which effectively multiplies the range of profit opportunities hugely. Examples of spreads is the wheat-corn spread, where traders speculate on the relative price of one to the other. Other spread opportunities occur in the price differentials between different delivery months of the same commodities’ futures contracts. Hence, you might buy the contract nearer to expiration and sell the one further out with the expectation that long-term prices of that commodity will fall with respect to near term prices.

Once you also realize that there are active options contracts in all the major instruments, it becomes clear that commodity trading is a very desirable niche within the universe of speculation.

As with all forms of trading, mental and financial discipline are key factors to success in commodity trading. Given their extreme volatility, it is paramount that you have a proven method before you ever speculate a single dollar in these often unpredictable markets.

You must also remember that these are real physical products involved, and they can literally be delivered if you fail to close out your position before the expiry of the commodity future or option contract. Otherwise, it can result in a truck pulling up outside your house with your delivery of soybeans, live cattle or cocoa - depending on what you have been trading. This has been known to happen!

That said, the opportunities present in commodity trading are huge and exciting. These are markets that see some real action, and you also have the pleasure of knowing that you are trading in real world items, which can give your trading a whole new meaning.

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This entry was posted on Sunday, May 25th, 2008 at 12:00 am and is filed under Investing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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