Commodity Trading: Oil, Gold & Everything Inbetween


Free Lessons to Learn To Trade Commodities Today
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We'll teach you to start commodity trading today…

Trading commodities like crude oil or gold may sound alluring because of the vast sums of money they generate in global commerce.

But trading commodities isn't a get-rich-quick scheme. Like any kind of market speculation, it is a skill that requires knowledge, talent, and dedication. Even then, it's extremely risky.

You've come to the right place to learn more. Below, we walk you through the steps involved in commodity trading: what trading instruments are available, popular market analysis strategies, and ways to mitigate your risks.

Where to Trade Commodities

Before you start trading commodities, you'll need to pick a broker. The broker you choose will determine your approach to the rest of the steps.

  • You'll need a broker that gives you access to the commodities exchange markets you're interested in.
  • Not all brokers are available in all countries.
  • Be sure to check that the broker offers a demo account.

Here's list of brokers that are available in :

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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 73.0%-89.0% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

If you need more help choosing a broker, check our overview of commodity brokers and then drill down to our detailed reviews of the ones on your short list.

Prepare to Trade Commodities

Before moving to the first step below, be sure you know:

  • Which commodities do you want to trade? Read our overview of the commodities market in general on our home page
  • Which trading instruments do you want? You can choose from physical delivery, CFDs, shares, ETFs, futures, or options.
  • Do background research. Successful commodity traders are avid readers and use the information found in scholarly articles, government websites, trade publications, the Farmers' Almanac, charting software, and other sources.
Gold bar and nuggets
Gold bullion (via Umicore on Wikimedia)

How To Trade Commodities

Here's a preview of the steps you'll take to learn how to trade commodities.

  1. Choose a commodities trading strategy.
  2. Mitigate your risk.
  3. Choose to buy or sell.
  4. Make a practice trade or a single test trade.

Now let's go into more detail on each step.

1. Choose a Commodities Trading Strategy

There are many commodity trading strategies. Those a trader chooses often depend on the trader’s skill level. Most strategies fall generally into one of two categories:

Fundamental Analysis: This strategy makes trades based on the economic factors that determine the value of an asset.

Traders that use fundamental analysis need to develop a keen eye for the supply and demand picture for a particular commodity. Supply and demand are opposing forces. Rising demand positively impacts prices; rising supply negatively impacts prices.

Commodity ETFs on Trading212.
Commodity ETFs on Trading212.

Technical Analysis: This strategy uses historical charts and data to analyze trends. Traders who use this strategy think historical price trends have predictive value for prices in the future.

They look for price points in the past where significant buying or selling occurred. They then place orders to trigger positions once those price levels occur again. Pure technical analysis traders pay no attention to fundamental factors in their trading.

Trading Analysis
Traders look at historical commodity prices to conduct their trading analysis (public domain).

Now let's take a look at some specific trading strategies. We've divided them into categories based on trading experience. You can hop directly to a section:

Strategies for Beginners

Traders with limited or no experience with commodities should stick to the most basic strategies for assessing markets.

Beginner Fundamental Analysis

In the case of fundamental analysis, this means paying attention to these items:

Production Levels: Beginning traders should look for broad trends in the output of individual commodities. Patterns in the level of crops being produced, metals being mined, and crude oil being drilled can offer clues about the direction of markets.

  1. Inventories: As with output, inventory levels can be a great fundamental investment tool. Persistent drawdowns in inventories often accompany higher prices, while inventory buildups usually lead to price declines.
  2. Macroeconomic data: Beginning traders should monitor trends in GDP, unemployment, and retail sales for clues about the strength of the economy. Strong data often coincides with rises in industrial commodity prices, while weak data can lead to lower prices.
Beginner Technical Analysis

Beginning technical analysis traders should familiarize themselves with the following charts:

  1. Line Charts: This is the most basic chart. It shows the price of the commodity on the y-axis and the date on the x-axis. Beginning traders should familiarize themselves with charting different time horizons such as hourly, daily, and weekly. Each of these charts can provide information about entry points and the length of time to hold an asset.
  2. Candlestick Charts: These charts show the open, high, low and closing prices for each period being graphed. This data is in the form of bars known as candlesticks. Technical analysis traders analyze the shape of candlesticks to predict future prices.

Learn about the different kinds of candlestick patterns.

Candlestick Charts
Candlestick charts are used in technical analysis.
(Image by PIX1861 under Pixabay License}

Strategies for Intermediate Traders

Traders with some experience can begin to incorporate more complex data into their trading strategies.

Intermediate Fundamental Analysis

Intermediate-level fundamental traders may want to delve deeper into the end markets for commodities. For example, strength or weakness in the commercial real estate markets in large cities offer clues about demand for steel and other industrial metals.

Similarly, the Cattle on Feed Report released by the USDA shows the future supply of cattle coming on to the market. This can offer clues about future beef prices.

Once traders become familiar with interpreting the significance of these data points, they can use them to make trading decisions.

Intermediate Technical Analysis

Intermediate-level technical analysis traders can begin to incorporate more sophisticated charting tools into their trading decisions:

  1. Uptrends: A series of higher highs and higher lows on charts indicates a bullish trading pattern.
  2. Downtrends: A series of lower highs and lower lowers on charts indicates a bearish trading pattern.

Traders can use charting software to draw trend lines on charts and identify these patterns.

Another strategy intermediate-level technical traders might employ is to compare charts of different assets. For example, crude oil and stocks enjoy a very high price correlation. If one of these markets is making a series of higher highs, then traders might expect the other to follow suit.

Learn about doji candlesticks.

Strategies for Advanced Traders

Experienced traders employ the most sophisticated trading strategies.

Advanced Fundamental Analysis

For fundamental traders, these include the following:

  1. Bull and Bear Cycle Analysis: Identifying long-term secular trends in markets can produce the largest profits of any trading strategies. Experienced traders look at the pricing of individual commodities compared to their long-term average prices. Differences in these two values often presage the beginning of long-term bull or bear markets.
  2. Broad Policy Assessment: Actions by central banks can presage movements in commodities prices. For example, a long period of easing by major central banks often leads to higher commodity prices, while a series of rate hikes can produce bear markets.
  3. Major Commodity Analysis: The price action of commodities such as oil and gold often precedes movement in lesser commodities. For example, an uptrend in oil prices might be a good reason to invest in other fossil fuels such as natural gas and heating oil.
  4. Production Output: Traders examine the output of leading producers for clues about big economic cycles. For example, companies might close mines and reduce output when metals prices are low. But these actions often indicate that a market bottom is forming. Using production output from leading producers as a contrary indicator can be a profitable trading strategy.
  5. Kondratiev Waves: This technique makes long-term predictions of commodity prices based on economic cycles.

A bear market, like a bear's claw attack, is in downward motion. A bull market, like a bull's attack with its horns, is in upward motion.

Advanced Technical Analysis

Experienced technical analysis traders also rely on more sophisticated strategies:

  1. Moving Averages: This strategy takes the average closing price for a certain number of periods and then graphs this information as a line above the price chart. When commodity prices trade through moving average levels, they can signal the direction of future prices.
  2. Breakouts: Traders chart resistance and support levels on charts based on historical levels. Breaches of resistance levels generally indicate a move to higher prices, while breaches of support levels often indicate lower prices.
  3. Fibonacci Analysis: Fibonacci analysis predicts retracement levels for commodity prices. These levels are derived from number sequences to predict the resumption of uptrends or downtrends in commodity prices.
  4. Commodity Channel Index (CCI): This powerful technical indicator generates buy and sell signals for commodities based on how overbought or oversold they are. The indicator is designed to profit from changes in price trends.

Retracement is a short-term reversal in the trend of a commodity's price after which the price returns to its original trend.

Although many traders consider themselves either fundamental or technical traders, this distinction isn't always true. The very best traders use elements of both forms of analysis in their trading.

For example, a trader may see production figures for gold dwindling. At the same time, the trader notices that the CCI indicates that gold is oversold. The confluence of these two indicators may be a signal to buy gold.

Read our deep-dive on all types of chart analyses.

2. Mitigate Your Risk

Before you begin trading, you must face the fact that it's a very risky endeavor. Here are some ways you can reduce your exposure.

Position Sizing

People trade commodities because of the leverage that can be used with them. But leverage is the main reason that most new commodity traders lose money.

Traders should research assess the historical price ranges of commodities. They should then use this data as a guide to calculate worst-case scenarios. They should enter positions in sizes small enough to enable them to make margin calls if markets move against them.

Risk Management

Sometimes the best-researched ideas simply don’t pan out the way we expect. Many novice traders hold on to losing positions and hope that they will return to profitability. This focus on increasing profits rather than limiting losses is a major mistake that traders at all levels must learn to avoid.

One way to avoid this problem is to place disciplined stops on commodity trades. A stop is a level below which a trader exits a long position. Using hard stops on trades is a way to ensure that small losses don’t turn into big losses.

Diversification

Purchasing a basket of commodities helps protect traders from the volatility of any individual commodity. It also adds diversification to a stock and bond portfolio.

Investing in a basket of commodities can accomplish three goals:

  1. It can provide protection against inflation.
  2. It can add diversification to a portfolio that is heavily invested in financial assets.
  3. It can protect a trader from the volatility of movements in individual commodities.

A basket is a group of commodities bundled together into one trading instrument.

3. Choose to Buy or Sell

As with stock and bonds, speculators in commodities markets look to buy an asset at a low price and sell it at a higher price. But commodity trading is different from stock and bond trading in three important ways:

  1. Leverage: Futures markets – the most liquid instrument for trading commodities – offer traders much more leverage than stock and bond markets. Increased leverage can produce both bigger gains and bigger losses.
  2. Volatility: Commodities can be much more volatile than stocks and bonds. Many of the factors that impact supply and demand for commodities can be hard to predict (eg, weather, social unrest, labor strikes, crop failures, etc.). When these factors change, commodities can suffer abrupt price changes.
  3. Fundamentals: Stock and bond markets have fundamental data points that drive prices. Price/earnings ratios, interest rates, credit ratings, and debt/equity ratios are some of the metrics traders use to price stocks and bonds. Commodities, on the other hand, have few if any such reliable metrics. Prices are usually driven by short-, intermediate- or long-term market sentiment. As a result, analyzing commodities markets is much more difficult.

Given these challenges, one might conclude that commodity trading is no different than playing games at a casino. But with the right approach, skill, and research commodities can be a profitable addition to a portfolio.

4. Make a Practice Trade

Many online brokers allow traders to create a demo account before making live trades. These practice accounts let you use play money on their live platforms to test drive your trading strategies.

Now you're ready to get started trading commodities!

Next Steps

We've got lots of great information about trading, so we encourage you to dive in and learn more:

FAQs

What are commodities?

Commodities are the raw materials that drive the economy. They are generally divided into soft commodities (agricultural goods) and hard commodities (metals and energy). These are the goods that are used as inputs into the manufacture of other goods. For example, wheat is used in the manufacture of flour and breakfast cereal.

Crude oil is probably the most important commodity. It is used to create other commodities like RBOB gasoline and heating oil. But even crude oil itself can be subdivided into Brent Crude and West Texas Intermediate (WTI). Crude oil is usually priced in terms of Brent Crude.

For an introduction to commodities, check out our primer.

How can I trade commodities?

Theoretically, commodities trading is easy: you sign-up with a broker and use their trading platform to buy and sell.

However, before doing so, you need to become an expert at both trading and the commonly traded commodities. You can begin learning about all this in the rest of this article as well as our commodities primer.

Can you make money trading commodities?

Some people make money trading commodities but the vast majority lose money. It is hard work and requires great knowledge. Even then, it is a very risky business.

Trading commodities can be harder than trading on the stock market. For example, commodity futures contracts require you to speculate on prices at a later date. And leveraged trades can cost you far more than you initially speculated.

How much do professional commodities traders make?

According to Glassdoor, the average commodities trader makes $30,559 per year plus $101,862 in additional compensation. But this amount can change dramatically with industry and experience.

According to the Houston Chronicle, a trader with more than 5 years experience can make a quarter-million dollars per year — or more. And those working in the banking industry make substantially more than those working for trading firms.

Are commodities high risk?

Commodities trading is very risky. In addition to the normal volatility of markets, commodity prices are affected by various external forces like the weather and the value of the US dollar. Commodities are also traded using leverage normally, which means that you could lose substantially more than you initially speculate. Never trade more than you can afford to lose.

What is the Commodity Futures Trading Commission (CFTC)?

The CFTC is a US governmental agency that regulates futures, options, and other trading derivatives. It is tasked with protecting traders from market manipulation and other abuses. It came into being with the Commodity Futures Trading Commission Act of 1974, which replaced the Commodity Exchange Act of 1936.

What are forward and futures markets?

Futures bind the seller to deliver an agreed-upon amount of a commodity for an agreed-upon price at an agreed-upon date. In exchange for this obligation, the seller receives payment upfront for the commodity. There are two kinds of contracts: forward and standardized (or just “future”).

How did modern futures trading evolve?

For 100 years after the start of the Chicago Board of Trade (CBOT) exchange, agricultural goods were the main commodities traded on futures exchanges. Over the course of the 20th century, other commodities were added — cotton in the 1940s, livestock in the 1950s, precious metals in the 1960s, and financial instruments in the 1970s.

In 1981, the Chicago Mercantile Exchange (CME) launched the first cash-settled futures. Upon expiration of a cash-settled futures contract, the seller of the contact does not physically deliver the underlying asset but instead transfers the associated cash position. This allowed trading on prices instead of physical goods.

Once the US Commodities Futures Trading Commission (CFTC) approved the Eurodollar futures contract, exchanges began listing cash-settled futures contracts on other commodities. By the 1980s and 1990s, futures trading expanded to stock market benchmarks such as the S&P 500.

The 21st-century brought online trading. Electronic marketplaces replaced physical trading floors. This change may have had the biggest impact on commodities futures markets since it made commodities trading available to millions of people around the globe.

Traditional Trading Floor
Traditional Trading Floor: NYSE (Pixabay License)

What are the top global commodities exchanges?

ExchangeFoundedDescriptionInteresting Fact
Chicago Mercantile Exchange (CME)1898This American financial and commodity derivatives exchange offers one of the largest menus of futures and options contracts of any exchange in the world.Began as the Chicago Butter and Egg Board, a dairy exchange.
Chicago Board of Trade (CBOT)1848A subsidiary of the CME Group since 2007, the CBOT offers more than 50 different futures and options across several asset classes.Oldest futures and option trading exchange in the world.
New York Mercantile Exchange (NYMEX)1882The world’s largest physical commodity exchange, the NYMEX was acquired by CME Group in 2008. Operates Commodity Exchange, Inc., (COMEX), a leading metals exchange.
Intercontinental Exchange (ICE)2000US-based electronic exchange that focuses on global commodities futures markets and cleared OTC products.Began as an exchange focused on energy markets.
London Metals Exchange (LME)1877UK-based exchange that offers futures and options trading primarily on base metals.Although formally founded in 1877, the exchange traces its origins back to the reign of Queen Elizabeth I in 1571.
Australian Securities Exchange (ASX)1987Australia’s primary securities exchange, ASX offers futures and options markets on agricultural, energy and electricity commodities. ASX merged with the Sydney Futures Exchange in 2006.
Tokyo Commodity Exchange (TOCOM)1984The largest futures exchange in Japan, TOCOM trades precious metals, energy and agricultural products including rubber.Formed from merger of the Tokyo Textile Exchange, Tokyo Gold Exchange and Tokyo Rubber Exchange.
Emerging Markets
Legend: Blue: Emerging markets, Pink: Established markets.
Emerging Markets by Alex Covarrubias based on the list from the website of Morgan Stanley (public domain).

What are the main drivers of commodity prices?

The supply of and demand for any given commodity are what ultimately drives its price. For example, if new reserves of iron are bound, it will tend to reduce its price.

But a new use of iron would tend to increase its price. Each commodity has unique factors that drive its price. However, certain factors play a role in determining prices for most commodities:

  1. Emerging Market Demand: fast-growing populous countries like India and China are accumulating vast amounts of wealth. They have a growing need for basic goods and raw materials. Demand from these markets has a huge impact on commodity prices.
  2. Inventory levels: major commodity consumers build up inventory levels. Filled and empty storage can indicate where prices will move.
  3. The US Dollar: most commodity prices are set in the US dollar which means that the value of the dollar compared to other currencies can affect commodity prices.
  4. Substitution: As prices for a particular commodity climb, buyers will seek cheaper alternatives.
  5. Weather: agriculture is highly dependent on weather but so are energy commodities like heating oil and electricity needed to power air conditioning units.

Credits: Original article written by Lawrence Pines with contributions from Commodity.com team. Major updates and additions in May 2020 by Frank Moraes.

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