Trading Commodities: Let’s Get Physical

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The commodities market, which is essentially the world’s oldest trading ground, offers interesting investment options, yet it differs from other assets available for online trading

One of the main aspects of online trading is choosing the right asset to trade. With so many different options in stocks, funds, currencies, indices and commodities, the choice can sometimes be overwhelming. However, if traders familiarize themselves with the different assets available, and know the characteristics of each financial instrument available, they will have an easier time making the choice that is right for them. A very popular investment option, and the first to ever exist, the commodities market presents some interesting options for traders.

While people have been exchanging commodities since the earliest days of civilization, a key turning point, which made them into a modern financial instrument, was the birth of the Chicago Board of Trade in 1848. In order to protect their crops and livestock from price fluctuations, American farmers and manufacturers would meet in Chicago to engage in future contracts, which operated as a hedging tool, to safeguard themselves from unpredictable changes in weather, yield or other unforeseen events.

The habit of buying and selling commodities before they actually exist, such as selling crops before harvesting season, evolved over the years to other fields. Oil, gold, coffee and many other physical raw materials are part of today’s commodities market, and they all have one thing in common. Unlike stocks or currencies, who usually only exist in the digital realm, commodity futures are actual physical goods, that are intended to be delivered to the buyer at the end of the contract. Traders saw this market as a way of making a profit, by buying contracts at certain price, and selling them later, if the prices go up.

This form of trading differs from others, since goods will eventually change hands. That’s why traders who deal with the actual market have an added element of time: When trading commodity futures, they wouldn’t like to hear the question “where would you like the cattle shipped?” Luckily, since online traders deal with CFDs, they only bid on price changes, rather than owning the actual contract. However, on many platforms, contracts do have a time limit and commodities cannot be held-on to indefinitely.

The physical aspect of the market gives it unique features. Oil is a great example. Since the global economy is literally fueled by oil, it is in constant demand, and prices are affected by the actual conditions of drilling, producing, and even shipping. However, since the commodity market deals in futures, it is also affected by perceived outcomes. For example, if oil producers go on record to say that they intend to slow down production in order to reduce stockpiles, this could lead to an increase in prices, since the supply/demand balance could be affected by such a move.

Another aspect to consider is how certain commodities relate to other assets traded on various markets. One prominent example is precious metals, and how they relate to the foreign currency exchange. Whenever there’s turmoil in the Forex market, some investors decide to turn to gold as a safe-haven asset. Since gold is a commodity, it is less affected by the differences in currency rates, and sometimes, goes up in value when currencies go down.

There’s much to know about the commodities market, and quite a few approaches to trading in it. Studying each commodity’s supply/demand scheme, how it is affected by events and announcements, and how it relates to other financial assets will give you a better starting point to make educated decisions when trading online.

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Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.

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