Commodities

What is Commodities Trading?

Commodity involves the trade of raw materials. There are many kinds of commodities you can trade, ranging from agricultural products like corn and soya beans, metals such as gold and copper, or energy products like natural gas or oil.
This particular instrument tends to have high volatility which can have an effect depending on the strategy that the trader uses. Some of the key factors that could cause high volatility can include supply and demand of a commodity, currency movements, geopolitical situations, government policies, and economic growth.

Commodity Basics

Some financial instruments can be volatile, this is especially so for commodity trading.

Understanding agricultural products, its produced quantity is not consistent throughout the year. This is because there are seasons where it’s time to sow and time to harvest. Apart from this, there are more unpredictable factors such as the weather, pestilence, or economic events that can cause either a great year for crops or the opposite. For a commodity producer, these changes can be worrisome.

Looking at an example, say a corn farmer. He sows his corn, harvests and sells it at prices depending on the aforementioned factors. The farmer’s dilemma is that he cannot predict the upcoming prices when the corn is ready to be sold. In order to offset this risk, he sells his corn to a hedger. A hedger is someone who is willing to buy the farmer’s crops even before they are ready. Then a person who agrees to buy the corn is known as a speculator who predicts that the price will be higher than the current price when the farmer is finally ready to deliver the corn. This is called a forwards contract.

commodities

Commodity Basics

Some financial instruments can be volatile, this is especially so for commodity trading.

Understanding agricultural products, its produced quantity is not consistent throughout the year. This is because there are seasons where it’s time to sow and time to harvest. Apart from this, there are more unpredictable factors such as the weather, pestilence, or economic events that can cause either a great year for crops or the opposite. For a commodity producer, these changes can be worrisome.

Looking at an example, say a corn farmer. He sows his corn, harvests and sells it at prices depending on the aforementioned factors. The farmer’s dilemma is that he cannot predict the upcoming prices when the corn is ready to be sold. In order to offset this risk, he sells his corn to a hedger. A hedger is someone who is willing to buy the farmer’s crops even before they are ready. Then a person who agrees to buy the corn is known as a speculator who predicts that the price will be higher than the current price when the farmer is finally ready to deliver the corn. This is called a forwards contract.

Futures

To explain futures, let’s illustrate this example with a farmer preparing to sow his crop in February. He is expecting to harvest the same crops in August and then deliver the goods in September. By that time, the price could be dramatically higher or lower. In the past years, the price for the same product rose up to $500 a bushel and fell to $200 a bushel. The speculator then agrees to buy at the price of $350 per bushel for delivery in September, hoping to resell at a higher price at that time. Now, the price fluctuation no longer matters to the farmer as he has already sold his crop or $350.

Commodity exchanges have standardized agreements known as futures contracts. The liquidity on the exchange is provided by the speculators and the exchange facilitates the coming together of hedgers and speculators. In our example, the farmer doesn’t have to seek a buyer for his crops nor feel troubled about the settlement of payment because the exchange claims responsibility ensuring that the speculators meet their end of the deal.

Futures

exchange

To explain futures, let’s illustrate this example with a farmer preparing to sow his crop in February. He is expecting to harvest the same crops in August and then deliver the goods in September. By that time, the price could be dramatically higher or lower. In the past years, the price for the same product rose up to $500 a bushel and fell to $200 a bushel. The speculator then agrees to buy at the price of $350 per bushel for delivery in September, hoping to resell at a higher price at that time. Now, the price fluctuation no longer matters to the farmer as he has already sold his crop or $350.

Commodity exchanges have standardized agreements known as futures contracts. The liquidity on the exchange is provided by the speculators and the exchange facilitates the coming together of hedgers and speculators. In our example, the farmer doesn’t have to seek a buyer for his crops nor feel troubled about the settlement of payment because the exchange claims responsibility ensuring that the speculators meet their end of the deal.