How to trade commodities is a question that comes up quite quickly when people start to be interested in commodities and not without reason. Trading commodities can be done in different ways, all depending on the time spent and risk taken.
One of the first thing to take into consideration when looking into commodities, is that they are traded, seldom invested in. Due to the nature of the commodities markets, investing is not possible except through funds. Nobody buys a futures contract and then waits for the kids to go to college.
This means that anyone interested in making money in the commodities markets needs to know how to trade commodities, and know it well. Any market participation calls for some knowledge of what is going on, but the commodities markets demand a more thorough knowledge on how they work and how to trade them.
For those wondering, what is commodity trading, the shortest answer would be “it’s the buying and selling of raw material”. This of course is the short answer, but those interested in the longer and a more detailed answer, might want to read on.
For decades, commodity trading has been shadowed by stock trading. It just wasn’t quite making it in the financial arena. It just didn’t make as good a party conversation as the stock market did.
Few years ago this began to change. Of course there had always been a group of people that traded commodities, but they were rather few compared to the amount of individuals that have been trading the stock market the last twenty to thirty years.
What is commodity trading
So what is commodity trading? Is it something mystical or is this just another hype to lure honest people into financial ruin? Or could it be that this is a highly profitable venue for active traders?
Long before man began to trade stocks and bonds, man had been trading commodities. From it’s beginning commodities trading has evolved and changed with changing times. Commodity futures trading has become a major trading arena where producers, merchants and speculators trade futures contracts for price protection and profit.
Commodity trading is different from trading stocks as to the fact that while stocks are based on the future expectations of the buyer, commodity futures have an underlying instrument. A person who owns one CBOT corn futures contract, is the holder of the right to 5.000 bushels of corn or 127 tons of corn, and if this contract is not offset before the contracts expiration date, the holder of the contract will be delivered the corn. As such there are tangible items connected to the contract. An owner of five shares of a company, is the owner of five shares of a company. He holds a paper saying that. This paper can be bought or sold, but the value of the paper is based on feelings and expectations, with no tangible items connected to it. It’s basically an IOU.
Valuating companies can be done in various way’s. One can look at the accounts, profits and losses. Different values can be calculated with reference to earnings pr. share, hidden property values or goodwill. Commodities are different as there is no one place to retrieve information. It’s not like a company where you can contact the office and get the latest annual report. The value of a commodity is based on things related to the physical presence of the underlying commodity. Weather, stock in warehouses, harvest and demand and supplies issues affect the valuation of the commodity. The vast amount of information needed to valuate the different commodities makes it difficult to put a certain price on each commodity.