History of Commodity Trading

The history of commodity trading markets dates back to early human civilization, rewarding producers and meeting the demands of users, independent of market price risks, always existing. What is required is an interchangeable and tradable contract to determine future prices, allowing traders/speculators to manage the risk component of transactions.

It is said that the origin of these "futures contracts" can be traced back to the early 19th-century wheat trade in the United States. By 1848, the Chicago Board of Trade (CBOT) was established, standardizing these contracts and becoming the counterparty to risk, thus enabling the trading of these contracts.

Fast forward to today, there are approximately 50 such commodity exchanges globally, facilitating the trading of commodity futures contracts and options.

Basics of Commodity Trading

What are Commodities?

Commodities are raw materials that can be grown, mined, or excavated, used in the production process to manufacture finished goods. Our everyday actions affect the commodity markets.

Whether extracted from beneath the Earth's surface or grown on its soil, commodities are the building blocks of almost everything we use in our lives. Over time, commodity trading has evolved to smoothen financial barriers between producers/miners and users/manufacturers, both of whom must make significant capital commitments before determining market prices.

Where are Commodities Traded?

Commodities are traded on exchanges through futures contracts, stocks, and ETFs, while they can also be bought and sold in their physical state. Some of the largest commodity exchanges in the world are:

• Chicago Mercantile Exchange
• Tokyo Commodity Exchange
• Euronext
• Dalian Commodity Exchange, China
• Multi Commodity Exchange
• Intercontinental Exchange
• Africa Commodities Exchange
• Uzbekistan Commodity Exchange

Some exchanges specialize in specific categories of commodity trading, including:

• Chicago Mercantile Exchange (energy and metals)
• ICE Futures US (agriculture)
• Chicago Mercantile Exchange (agriculture)
• LIFFE (agriculture)
• London Metal Exchange (non-precious metals)
• ICE Futures Exchange (energy)

Are Commodities Regulated?

Each commodity market has a primary regulatory body, similar to how stocks are supervised. In the United States, the main regulatory body is the Commodity Futures Trading Commission (CFTC), while the Financial Conduct Authority (FCA) in the UK performs similar functions. Other well-known regulatory bodies from around the world include ASIC (Australia), BaFIN (Germany), FMA (New Zealand), FINMA (Switzerland), and FSA (Japan).

What are the Major Commodities?

Tradable commodities are divided into several categories, including grains, softs, livestock, energy, metals, and "others."

• Softs (cocoa, coffee, cotton, orange juice, sugar)
• Livestock (feeder cattle, live cattle, lean hogs, pork bellies)
• Energy (Brent crude oil, West Texas Intermediate crude oil, gasoline, heating oil, natural gas)
• Metals (steel, copper, iron, gold, nickel, palladium, platinum, silver, aluminum)
• Others (lumber, rubber, wool)

What are Hard and Soft Commodities?

Traders often encounter the terms "hard" and "soft" when describing commodity types.

• Hard commodities are any commodities that must be mined (gold, silver) or extracted (rubber, petroleum).
• Soft commodities describe anything of an agricultural nature (corn, soybeans, wheat, rice).

What are the Most Valuable Commodities?

Oil is the most valuable trading commodity. Energy is referred to as the "mother of all markets," accounting for about $13 trillion of the global GDP, roughly 3.6% of the world's GDP.

Oil tops the product list, further categorized into various qualities of crude, heating oils, and its sibling natural gas. Crude oil also plays a role in the production of almost every other commodity on Earth, as well as plastics, cosmetics, pharmaceuticals, fertilizers, computers, synthetic fibers, and so on.

What are the Top 10 Most Traded Commodities in the World?

According to data from the Futures Industry Association (FIA), the top 10 most traded commodities in the world include:

• Brent crude oil
• Steel
• West Texas Intermediate crude oil
• Soybeans
• Iron
• Corn
• Gold
• Copper
• Aluminum
• Silver

Commodity Risk Factors

Everything from weather to competition to inventory on hand can cause extreme market fluctuations in prices. These dramatic market fluctuations are referred to as volatility – a general measure of risk in any given market.

Volatility – a natural prerequisite for trading profits – is high in commodity markets. For this reason, commodity trading is considered to have high-risk characteristics, meaning there is potential for high returns but also for high losses.

Commodity trading requires specialized education and training, time spent practicing with simulated trading accounts, access to information from various sources and absorbing it, a specific trading plan that will mitigate risks, a disciplined approach, and most importantly, patience. It's also crucial to ensure that emotions never interfere with the decision-making process.

Trading Commodities Online?

How to Start Commodity Trading?

Like any other trading discipline, you'll need a broker as a "partner" who provides you with the products you like, security, support, and fees. An easy-to-use trading platform can make all the difference. If there's a "trick," it's finding a broker that strikes the right balance between fees and platform tools.

If the fees are low, the platform might be designed for professionals and might not suit your taste.

Brokers have also adapted to the electronic age; there's no longer a need to call a broker for a quote. Nowadays, technology enables you to trade via desktop, smartphone, or tablet, and on the move (as long as the exchanges in your chosen time zone are open). Brokers with global operations can also offer access to foreign markets and provide trading opportunities in more external commodity exchanges.

Best Ways to Trade Commodities

The best way to trade commodities is a method that matches your trading personality and tolerance for risk, so you won't lose sleep at night. Depending on your risk tolerance and preference for commodities, you can trade commodities through the following six methods:

• Traditional holding of producer stocks
• Exchange-traded funds (ETFs)
• Mutual funds, managed funds, or index funds
• Contracts for Difference (CFD)
• Futures options
• Futures contracts

For the latter three methods, ample leverage is provided, whereas basic stock margin rules apply to the first two items. There's a trend in developed economies where regulatory authorities have taken steps to limit the use of leverage in high-risk investment instruments. Leverage can amplify your potential returns, but it can also amplify your potential losses. Learn to use it wisely.

Can You Make Money Trading Commodities?

Profits are possible if traders understand how demand and supply, among a host of other factors, affect the commodity markets, particularly because this medium is highly volatile. Current estimates suggest that the volatility of commodities is at a "three times" multiple of the forex market, which is known for its dramatic price swings.

Many investors find commodities an excellent way to diversify their investment portfolios, as these assets often behave differently from others when under pressure. Commodities also serve as a hedge against inflation due to their intrinsic value priced in dollars.

Finally, globalization and population growth are creating new wealth potential in developing countries, which aspire to higher standards of living, meaning demand for commodities is likely to increase over time, a foresighted long-term trend.

There are numerous commodity trading tips and strategies that will help you maximize trading profits in the commodity markets.