A commodity includes any primary goods that can be used as a stable bargaining unit. Most of the exchange trading revolves around raw materials such as oil or gas. This category includes various non-ferrous and ferrous metals, industrial raw materials (for instance, caoutchouc) and even animals (cattle and small ruminants). The main characteristic of an exchange commodity is immutability, homogeneity, convenience in calculating volumes and value. The value of each product category is determined by global supply and demand, which creates healthy competition on the exchange.
So, where to start trading commodities?
Step 1. Learn distinctive properties of exchange commodities
The very first exchanges, which appeared in Europe in the Middle Ages, were precisely commodity ones. They traded on the most relevant and popular goods at that time — pepper and other spices, as well as all sorts of agricultural products. The difference between exchange trading and ordinary market trading (in the bazaar) were such properties of exchange commodities as:
- Standardization (different batches must have the same properties);
- And besides that, the goods traded on the exchange were not supposed to be perishable;
- Their characteristics should also include the possibility of storage, transportability, and the possibility of dividing into separate parties (lots).
The need for such properties is due to the specifics of exchange trading. The bottom line is that the price set on the exchange applies to absolutely all batches of this or that type of goods traded on it. Therefore, it is unacceptable for one batch to differ in its properties (or in its quality) from another batch of a similar product. And besides this, a buyer who makes a deal at a set exchange price must be sure that he will eventually receive a product of a certain quality.
At present, all these properties have retained their relevance, except for perhaps only one — modern exchange trading can be carried out, including perishable goods. This has become possible thanks to current technologies and advanced logistics.
Step 2. Inquire about the main types of commodities
If you want to start commodity trading, study the products and their features, including on the exchange. Themed blogs such as Forextime can help you with their advice and educational materials not only for commodities but also for Forex trading.
Energy raw materials:
- natural gas, etc.
Products of the agro-industrial and agricultural sector:
- orange juice concentrate, etc.
Raw materials for textile production:
- wool, etc.
Raw materials for industrial production:
- processed lumber
- ore, etc.
- a scrap of ferrous metals;
- non-ferrous metals;
- precious metals, etc.
Step 3. Learn peculiarities of commodity trading on futures and options market
Most of the transactions with exchange commodities take place on the so-called derivatives market. Such contracts are commonly referred to as derivative financial instruments. These include options and futures contracts.
This type of commodity trading is not accidental and also has its own historical background. Take, for instance, futures contracts. Their essence lies in the fact that a transaction concluded today entails the delivery of the corresponding product not immediately upon conclusion, but after a predetermined period in the future. At the same time, both parties to the futures contract take on specific obligations, guaranteeing delivery and payment within a predetermined time frame.
Options contracts also imply the delivery of goods after a certain period in the future, but at the same time, their parties do not assume any obligations but are endowed with only the right. In other words, if the execution of a futures contract is mandatory, then it is quite possible to refuse the terms of an option contract (this, by the way, is their key feature).
Suppose there is a pastry chef in Nigeria who bakes various delicacies from dough mixed with wheat flour, and there is a farmer who grows the very wheat from which this flour is ground. Now imagine that a pastry chef decided to take out a loan to expand his business and, after making calculations, came to the conclusion that he could easily pay it, but on the condition that grain prices would not rise in a year. He enters into a futures contract for the delivery of wheat in one year at the current price and, at the same time, quietly takes the necessary credit.
In a year, the price of wheat may remain at the same level. Or maybe the price will change (which is more likely), and in this case, two options are possible:
- Wheat prices will rise. In this case, the confectioner will receive wheat at a low price, and the farmer will have to supply it (although at current prices he could sell it much more expensive);
- Wheat prices will go down. In this case, the pastry chef will receive wheat at a higher price (than what is available on the market) and he will have to put up with it. At the same time, the farmer will benefit because the given consignment of goods (in the amount specified in the futures contract) will be sold at a price higher than the market one.
But what if instead of a futures contract, an option contract were concluded? In this case, neither the farmer nor the pastry chef would have any obligations. Both the one and the other could refuse to fulfill it: the farmer could not supply wheat at a low price (in the event of an increase in prices for it), and the pastry chef could buy it cheaper (in the event of a decrease in wheat prices).