How to trade commodities: A comprehensive guide for beginners

Wondering what are commodities and how they impact the market? This guide explains the types, price factors, and how to trade commodities successfully.

The concept of trading commodities is relatively straightforward. If you think the price of oil, gold, or another commodity will go up, you can buy some and sell it at a later date.

However, whether you’re trading energy commodities, precious metals, or agricultural goods, the reality of actual commodity trading can be a little more complicated. Do you actually have to take delivery of 50 tons of wheat? Where are you going to put 200 head of cattle?

Yes, even cattle are real commodities that you can trade, but no, you don’t have to worry about where you’re going to store them. Even though the assets themselves can be simple, the commodities trading market is highly sophisticated and financialized, allowing anyone to trade without ever needing to come into contact with the physical product.

In this article, we’ll cover how to trade commodities, giving beginner traders everything they need to know to get started.

Content: 

1. Introduction to commodity trading
2. Types of commodities
3. Factors influencing the price of commodities
4. Benefits of commodity trading
5. Risks of commodity trading
6. Methods of commodity trading
7. Steps to start trading commodities
8. Common questions
9. Key takeaways
10. Final thoughts

Introduction to commodity trading

Before you start trading commodities, you must understand that they can be highly volatile, leading to increased levels of risk. Despite this risk, they do offer the potential for attractive returns. 

With that out of the way, let's first define what a commodity is.

What are commodities?

Commodities are tradable goods and resources where each unit of the good is effectively the same as the others. In recent years, you may have heard of NFTs or non-fungible tokens, where each token is unique. Commodities are the opposite in that they are fungible, and each unit is not unique.

For example, a barrel of crude oil of the same quality level will have equal value, whether from Kuwait, Australia, or West Texas. There are a large number of widely traded commodities from all over the world, and some of the most common are:

• Crude oil
• Natural gas
• Gold, silver, and other precious metals
• Wheat
• Corn
• Sugar
• Live cattle

The commodity markets play a huge role in the global economy. Events impacting producers of these commodities, such as natural disasters or war, can cause a ripple effect that creates inflation or supply chain bottlenecks.

Types of commodities

Broadly speaking, commodity markets are split into two main categories:

Hard commodities

The simplest way to classify hard commodities is to categorize them as resources or products extracted from the earth and processed. Natural resources like oil, gold, and natural gas are all examples of hard commodities. 

Soft commodities

Soft commodities, on the other hand, consist of goods that need to be grown and cared for. The most obvious examples include livestock and crops such as wheat or soybeans. 

Factors influencing the price of commodities

Commodities are real-world goods, and their prices are impacted by real-world events, such as:

Supply and demand dynamics

Supply and demand principles significantly impact the price of commodities. For example, the increased demand for lithium batteries in products like electric cars has seen the price of lithium increase substantially in recent years. 

Conversely, oversupply, such as a bumper growing season for wheat or corn, can lead to prices falling.

Geopolitical events

Wars and political instability can wreak havoc on commodity production, leading to supply issues. If a country that is a significant grower or producer of a particular commodity were to be invaded and go to war, it could cause prices to spike as supply drops.

Economic indicators

While less volatile, general economic conditions will impact the prices of commodities. Economic growth can lead to higher consumption levels across the commodity spectrum, while a struggling economy will do the opposite. The impacts on prices can be less dramatic but can also last substantially longer.

Currency fluctuations

Commodities are generally priced in US dollars on global markets, meaning currency fluctuations can significantly impact their prices. 

When the dollar strengthens, commodities become more expensive for buyers using other currencies. This can dampen demand and push prices lower, and vice versa if the dollar weakens. 

Local currencies in commodity-producing countries can also influence production costs and export competitiveness, impacting global prices.

Benefits of commodity trading

Diversification

Commodities provide a valuable diversification aspect to an investment portfolio, as they tend to have a low correlation with traditional financial assets like stocks and bonds. This means that when stock markets decline, commodities may still perform well, helping to balance risk.

• Commodities often move independently from stocks and bonds, reducing overall portfolio volatility.
• Diversification with commodities can enhance long-term returns by reducing reliance on a single asset class.
• Certain commodities, such as agricultural products and metals, can offer stability during economic downturns.

Inflation hedge

Many commodities, particularly hard assets like gold, silver, and oil, serve as a hedge against inflation. Since commodities are tangible assets, their value tends to rise alongside inflation, preserving purchasing power.

• Gold and precious metals often hold their value when fiat currencies lose purchasing power.
• Energy commodities like oil and natural gas typically see price increases when inflation rises due to higher demand and production costs.
• Agricultural commodities such as wheat and corn can become more valuable as food prices increase with inflation.

High return potential

Commodities can experience rapid price movements, providing traders with the potential for significant profits.

• Supply chain disruptions, natural disasters, or geopolitical events can cause commodity prices to rise sharply within a short period.
• Traders who correctly anticipate market trends can capitalize on price swings for substantial gains.

Global market access

Unlike traditional stock markets, which are often country-specific, commodity markets are global, meaning traders can access opportunities from around the world.

• Investors can trade commodities linked to economies and industries worldwide, such as crude oil from the Middle East or coffee from South America.
• This global exposure helps traders diversify geographically and mitigate country-specific economic risks.

Multiple ways to trade

Trading within commodity markets isn’t limited to buying and holding physical assets—numerous financial instruments are available.

• Futures contracts allow traders to speculate on price movements without owning the physical commodity.
• Commodity ETFs provide a simple way for investors to gain exposure to a basket of commodities.
• Commodity stocks allow indirect investment in commodities through companies engaged in production and extraction.
• CFDs (Contracts for difference) enable traders to speculate on price movements without owning the underlying asset.

Risks of commodity trading

Volatility

The prices of commodities are highly volatile and can be influenced by multiple unpredictable factors, including supply chain disruptions, extreme weather conditions, political instability, and changes in consumer demand.

• Natural disasters such as hurricanes or droughts can significantly impact agricultural commodities and their prices.
• Geopolitical events like wars or trade disputes can create sudden supply shortages, leading to price spikes.
• Shifts in global demand, such as an increase in electric vehicle sales, can boost lithium demand, driving up prices unpredictably.

Leverage risks

Many commodity trades involve leverage, allowing traders to control large positions with a relatively small initial investment. While this increases potential returns, it also magnifies risks.

• Small price movements can result in large percentage losses if leverage is used incorrectly.
• Margin calls can force traders to deposit additional funds or close positions at a loss if the market moves unfavorably.
• Uncontrolled leverage can lead to losses exceeding the trader’s initial investment, making risk management essential.

Market speculation risks

Unlike traditional investments based on company earnings or dividends, commodity trading is often driven by speculation, making prices susceptible to rapid shifts.

• A commodity's price can be influenced by market sentiment, investor speculation, and external shocks rather than intrinsic value.
• Speculative trading can lead to bubbles and crashes, as seen in the oil markets during price fluctuations.

Storage and logistics issues (for physical trading)

For investors looking to trade physical commodities, logistical challenges like storage, transportation, and insurance can add additional costs and risks.

• Storage costs for commodities like crude oil or agricultural goods can be high and fluctuate based on market conditions.
• Spoilage risk exists for perishable goods like livestock or crops if not managed properly.

Regulatory and political risks

Commodity markets are subject to regulatory changes, tariffs, and government interventions, which can impact price stability and trading conditions.

• Changes in government policies, such as export bans or subsidies, can affect supply and market demand.
• Trade restrictions and tariffs between countries can create market inefficiencies and unexpected price swings.
• Regulatory compliance requirements may vary depending on the trading platform and jurisdiction, affecting accessibility and costs.

Methods of trading commodities

As with many asset classes, there are multiple ways to gain exposure to commodity price movements. There’s no right or wrong way; the best method depends on each l trade and the circumstances surrounding it.

Futures contracts

A futures contract is simply a purchase agreement to be completed at a future date. The buyer and seller of the contract agree to a price that will be paid on a specific future date for an asset like a commodity.

As a financial instrument, commodity futures contracts have their own market, allowing traders to buy and sell contracts based on their expectations of price movements of the underlying asset. 

Commodity CFDs (Contracts for difference)

A commodity CFD is a financial instrument that allows traders to profit from commodity price movements without owning or being obligated to buy the underlying physical asset. 

The buyer and seller agree to exchange the difference in the commodity's price from the contract's opening to its closing. Like futures, traders can profit from both rising and falling commodity markets.

Commodity ETFs (Exchange-traded funds)

Commodity ETFs are investment funds that aim to replicate the performance of a specific commodity or a group of commodities. These funds provide an easy and cost-effective way for investors to gain exposure to commodities without directly buying or managing the physical assets. 

These funds are traded on a stock exchange, meaning they can be easily bought and sold like stocks. It’s important to note that, unlike the other methods, ETFs charge ongoing management fees.

Commodity stocks

Commodity stocks represent shares in companies that produce, extract, or process commodities. For example, traders expecting gold prices to rise may invest in gold mining stocks, as an increase in gold prices would typically drive up the stock prices of mining companies.

This method can be a useful way to gain exposure to less widely traded commodities, but it also comes with the risks of stock investing. For example, even if the gold price were to increase, poor management could result in a declining stock price for some gold mining companies.

Steps to start trading commodities

1. Choose a trading method

Each of the methods outlined above has pros and cons. Deciding whether to use CFDs, futures, ETFs, or stocks to trade on commodity prices comes down to your risk tolerance, the amount of capital you have to trade with, your knowledge and experience, and the amount of time you plan to dedicate to managing your money.

1. Select a reliable trading platform

When it comes to your money, you need to trust the companies you use. While comparing platforms on features and fees is important, it’s even more important to ensure your chosen platform is regulated and secure.

Before you begin, you must ensure the platform you choose offers the commodities and financial instruments you’re interested in.

1. Develop a trading strategy

Next, you must decide how you will research and execute your trades. Some trades rely on fundamental analysis, which examines economic factors and government policies to assess whether a commodity's price will likely go up or down.

Others use technical analysis, watching charts for specific patterns that may indicate a price rise or fall. Many traders use a combination of both of these methods.

1. Risk management

Arguably, the most important aspect of any trading strategy is minimizing your downside. Implementing strategies like stop loss orders (an automatic sell order if a price drops below a trigger point) and practicing good diversification processes can go a long way.

Common questions about commodities

What are the most traded commodities?

Gold, oil, natural gas, silver, coffee, and agricultural products like wheat and corn are some of the most widely traded commodities globally.

How do I start trading commodities?

Choose a trading method (e.g., futures, CFDs, ETFs, or stocks), select a reliable platform, and develop a strategy that suits your goals and risk tolerance.

What affects the price of commodities the most?

It will depend on the specific commodity, but factors like geopolitical events, supply and demand issues, broad economic indicators like GDP growth, and currency fluctuations can all affect prices.

Is commodity trading risky?

Yes, commodities can be volatile, and leveraged trading increases the risk of significant losses. Risk management strategies are essential.

Key takeaways

1. Commodity trading provides valuable diversification benefits for investment portfolios, helping to reduce overall risk and enhance potential returns.
2. Commodities can act as a hedge against inflation. Assets like gold have historically retained value when currency purchasing power declines.
3. Price movements in commodities are influenced by real-world factors, including supply-demand dynamics, geopolitical events, economic conditions, and weather patterns.
4. Commodity prices can be highly volatile, creating opportunities for significant gains while still carrying substantial risks for traders.
5. Leverage in commodity trading can amplify profits, but it also increases exposure to losses, requiring careful risk management and strategy.
6. Understanding economic indicators such as GDP growth, inflation rates, and interest rate policies is crucial for predicting commodity market trends.
7. Currency fluctuations impact global commodity prices, as most are priced in U.S. dollars, affecting affordability for international buyers.
8. Different trading methods, such as futures, CFDs, ETFs, and stocks, provide traders with various ways to gain exposure to commodities based on their experience and goals.
9. A reliable and well-regulated trading platform is essential for seamless transactions, market access, and protecting financial assets.
10. Risk management strategies, such as stop-loss orders and portfolio diversification, are critical for safeguarding capital in this highly dynamic market.

Final thoughts

Commodities are a relatively simple asset class. However, to benefit from a profitable trading strategy, you need to gain a thorough understanding of the broader economic environment that impacts their prices. 

Luckily, there are many ways to gain exposure, which require varying levels of knowledge and experience. Starting with ETFs may be a good introduction to commodity markets while you learn more about trading CFDs and other methods to profit from commodity price movements.

The best way to learn is by doing. This is why Exness offers a risk-free demo account. You can sharpen your skills and test your strategy without risking your capital. And once you’re ready to start trading with real money, we’ve got your back with 24/7 support.