What Is Commodity Trading?
Commodity trading is the exchange of different assets, typically futures contracts, that are based on the price of an underlying physical commodity. With the buying or selling of these futures contracts, investors make bets on the expected future value of a given commodity. If they think the price of a commodity will go up, they buy certain futures—or go long—and if they think price the commodity will fall, they sell off other futures—or go short.
Given the importance of commodities in daily life, commodity trading began long before modern financial markets evolved as ancient empires developed trade routes for exchanging their goods.
“Commodities trading is properly the birth of modern investing—the ceiling of the New York Stock Exchange is adorned with gold tobacco leaves in homage to the commodity trading that gave birth to the institution,” says Giannotto.
Modern commodity trading in the United States started in 1848 at the Chicago Board of Trade. It allowed farmers to lock in sales prices for their grain at different points during the year rather than only at harvest, when prices tended to be low. By agreeing to a price ahead of time through futures contracts, both the farmer and the buyer gained protection against price changes.
Today, the commodities market is much more sophisticated. Not only is there a long list of varied commodities being traded, but it’s also an international market with exchanges around the world. You can trade commodities nearly 24 hours a day during the workweek.
What Are Commodities?
Commodities are raw materials that are used to produce finished goods. Commodities include agricultural products, mineral ores and fossil fuels—they’re basically any kind of natural resource that is consumed by companies and individuals. Commodities are physical goods that are bought, sold and traded in markets, distinct from securities such as stocks and bonds that exist only as financial contracts.
There are four main types of commodities:
- Energy. The energy market includes oil, natural gas, coal and ethanol—even uranium. Energy also includes forms of renewable energy, like wind power and solar power.
- Metals. Commodity metals include precious metals, like gold, silver, palladium and platinum, as well as industrial metals, like iron ore, tin, copper, aluminum and zinc.
- Agriculture. Agriculture covers edible goods, such as cocoa, grain, sugar and wheat, as well as nonedible products, such as cotton, palm oil and rubber.
- Livestock. Livestock includes all live animals, such as cattle and hogs.
Commodities prices shift constantly as supply and demand change in a single economy and around the world. A bad harvest in India could lead to higher grain prices while climbing oil production in the Middle East could depress the global price of oil.
Investors in the commodity market aim to profit from supply and demand trends or reduce risk through diversification by adding different asset classes to their portfolios.
“The real advantages to commodity trading are differentiated exposures from the stock market and the potential for inflation protection,” says Ryan Giannotto, chartered financial analyst (CFA) and director of research at GraniteShares, an ETF issuer based in New York City.
