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Commodity Trading – A Basic Guide

Commodity Trading – A Basic Guide

Commodity trading has a rich and colorful history going all the way back to the mid 1800s. Our “Industrial Revolution” brought new technologies and abilities to produce more efficient tools and consequently more food. As our economic output began to out-pace population growth, we developed a need for more efficient agricultural storage, transportation and distribution of goods.

As the quantity of goods increased exponentially, “futures markets” with reliably uniform commodity pricing, grading and delivery became an absolute necessity in order to deal with the seasonal gluts occurring just after harvest and sharp shortages occurring before harvest. Farmers and investors could now protect themselves from price fluctuations by locking in specific prices for commodities long before actually needing to take physical delivery of them.

So the “Futures Market” and “Commodity Trading” was born. Without a doubt there is a tremendous amount of potential profitability available in commodity trading, but you most definitely need to have a clear and deep grasp of the basic principles of trading futures before you jump into action.

First of all, let’s discuss exactly what a commodity is. By definition, a commodity is an article of trade or commerce, something of value that is either completely unrefined or at least partially unprocessed. A commodity is a tangible, physical product, as opposed to a service that is to be rendered.

An item must meet certain specific standards to be considered a “commodity” and be traded in a futures market. First of all, a commodity must be “standardized.” This means that a single unit of a particular commodity will always be precisely as valuable as any other unit of the very same commodity. So whether we are talking about a barrel of oil, a bushel of wheat, a ton of iron ore or a particular value of foreign currency, commodities have a standardized and set value.

This is precisely why such items as art or jewelry is not considered a commodity. Each piece is distinctly one of a kind and totally unique unto itself. Therefore the value differs and fluctuates tremendously from one piece to another.

Commodities can either be traded on “spot markets” or in the form of futures. In spot markets, commodities are traded immediately in exchange for cash or some other good.
Meanwhile, commodities traded in the form of “futures,” which are often referred to as “options,” what is actually traded is not “the goods themselves, but instead a contract to buy or sell the commodity for a certain price by a stated date in the “future.”

As most commodity trading is done in the form of futures and options, there is a large amount of speculation involved in making accurate predictions with regards to the eventual values of items being traded. This naturally creates near limitless speculative uncertainty, with huge potential for profitability as well as the risk of devastating loss.

Such speculation is an amazingly complex process of factoring in as much tangible information as possible to make what one hopes to be a reasonably rational prediction, based on analysis of current conditions. For example, speculation on wheat options would take into account the total amount of acreage that has been planted, both the organic and mineral condition of the soil, moisture levels in the soil and atmosphere, as well as best “guesstimates” regarding weather condition for the coming months.

As if that’s not enough to try to calculate, what if there is a cataclysmic flood or fire, what if there is a transportation strike or political upheaval, what if drastic change in the marketability of a crop, such as a perceived medical emergency and ban placed on a particular commodity?

In other words, no one can feel absolutely 100% certain about the future price of a particular commodity, which is precisely why they call it “speculation.”

Think of commodity futures as being much like a wholesale market, where transactions are done in large bulk. So while you may go to the grocery store to buy a pound of sugar, in the commodity futures market, investors are buying 200,000 pounds! Instead of filling his gas tank with an average of 20 gallons of gasoline, a commodities trader is purchasing more along the lines of 50,000 gallons.

Another big difference for you to keep in mind is that while you expect the go home with your bag of sugar and gas gauge on full, the commodity trader never actually expects to see a single grain of sugar or a drop of gasoline. That’s because their purchase is “the contract” for the goods, which might be bought and sold a number of times before the goods are ever even manufactured and delivered.

So a person who is truly willing to do their homework and study the process from point A to point Z or one who has complete confidence in their advisors “hot tips” or possibly a powerfully reliable “extra-sensory gut intuition” can make astronomical profits in the commodities market.

So it’s wise to go into the trade knowing that there is a definite reason they refer to this as “speculation,” so be smart about how much you invest and where you invest it, keeping your goals and time-lines in mind when calculating the risk that you can afford to place yourself in, hoping to beat the odds and strike it rich with a few well placed orders.

For oilprice.com who specialise in oil prices




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Leave a comment
  • April Cook on July 19 2016 said:
    I've always wondered what commodity trading was, and this article did a great job explaining things. i didn't realize that an item had to have a set value to be considered a commodity. Who sets the prices? How often do hey change? Thanks for this great information!

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