What Are Commodities And How Do They Work In The Financial Market?

Commodity! Sounds like a synonym for the word “goods”. Many traders, who trade in the Exchange Market use the word a lot without a proper definition or insight of what the word means and even those who do have little or no clue on how they are traded on the Financial or Exchange Market.

In this article, I will try to explain in-depth what are commodities, how they work and how they can be traded in the Financial Market.

Keep in mind that commodities are similar and goes along with stocks, bonds, currencies and other assets. Just like any other investment or financial instrument or asset it needs a good knowledge

What are commodities?

The word “commodities” is used to refer to anything or object that comes out of the Earth, ranging from agricultural products such as Wheat, Soybeans and Corn to energy such as Coal, Natural Gas and Oil down to metals like Gold, Silver, platinum etc.

Commodities of the same grade and type are considered fungible.

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Fungible means that commodity can be interchanged with other commodities of the same grade and type irrespective of which country it came from or who produced it.

Let me further explain with an example. If a drilling company in Nigeria produces a high grade crude oil and another company in Venezuela also produces that same crude oil, the crude oil in the that both company produces is fungible as long as they are in the same grade and it doesn’t matter where it came from.

Who can trade this commodity?

As I had earlier said, commodities are similar to stocks, bonds, index, etc. That means they can be traded by anyone with the capital and trading knowledge.

Though investors, hedge funds managers, speculators, consumers, manufactures, famers, miners etc. can buy and sell different commodities for various reasons.

The main players in the market are those who buy or sell commodities to hedge their risk in the future market.

For example, a fruit juice manufacturer who has his factory in Namibia might need 10 tons of orange in the next 4 months from a famer in United States, based on the fluctuating exchange rate between both nationalities and the geo-political news. He might agree to pre buy the oranges from the farmer in the US before they are even ready to be harvested by the farmer, in doing so both the manufacturer and the farmer will agree on a pre-defined price at which they will transact in the future, in doing so they have successfully protect themselves from further price fluctuation in the market.

Various commodities like the one explain in the example above are all concluded in the future market.

READ: Reasons Why You Should Invest In Agriculture in Nigeria

Similar to stocks and currencies not everyone buy them to offset their risk or buy them to hedge price movement, some do trade them to make profit by speculating each commodities price movement.

How are Commodities Traded?  

For the big players in this market, commodities can be bought or sold at Commodity Exchange such as Chicago Board of Trade (CBOT), Intercontinental Exchange and the New York Mercantile Exchange (NYMEX).

Those who have the capital can buy from the producers directly. But for speculators like you and I, who do not have millions of dollars to use and trade commodities can also trade through discount brokers, who are like the regular brokerage firm that accept client with smaller trading capital.

How to Trade commodities through Discount Broker

There are different kinds of brokers, each with their own trading conditions and the type of clients they accept. But for clients with smaller trading capital, using a discount broker is the best choices.

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Such brokers offer energy commodities, which is among the most popular one traded by majority of retail traders include crude oil (WTI and Brent), Natural gas. Metal commodities such as Gold, Silver and platinum and Agricultural commodities which are soybeans, corn and wheat.

Unlike in the Exchange Floor, where physical delivery is mandatory, discount brokers only trade commodities through Contract for Difference (CDFs), which allow retail traders to speculate on the price movement on itself and not the physical delivery.

Other Ways to Trade Commodities

Apart from buying commodities either from the Exchange Floor or Future Market or even directly from the manufactures or through discount brokers.

One can also buy stocks from companies that deals on each commodities.

Example, buying shares of Barrick Gold is similar to buying an ounces of a gold bar because Barrick Gold is a company that mine gold and the price of Gold at the financial market will affect the company, but that’s a better way to invest and less risky.

READ: 4 Financial Risk Businesses Face in Nigeria

Things to Know About Commodities.

The general price of commodities are driven by DEMAND and SUPPLY. When the demand of a particular commodity is high the price increase and vice visa in terms of supply.

In other to fully trade the commodity market and be profitable, you need the basic knowledge of how each commodity reach to price movement as well as news.

I also advise new and inexperience traders to see trading as a business and treat it as such by getting adequate trading capital and the right knowledge along with a trading plan and patience.

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