How to trade commodities: A guide to commodity trading
Updated: September 06, 2024
Since 18481, commodity trading has been the pinnacle of the American economy. It started with grain and livestock but has grown into a global economy, all accessible by the internet. Today, we don’t trade at the market as we used to in days gone by, but commodity trading is still alive and well in modern America.
With the right investments, commodity trading can become a lucrative financial venture with big rewards. Still, it’s not without its risks. Understanding how commodity trading works can help you learn how to trade commodities so you can expand and diversify your financial portfolio. But first, there is the question of how to trade commodities.
This is a comprehensive guide to commodity trading, including where and how to invest.
What is a commodity?
A commodity is a raw material that is used in the manufacturing and sale of consumer goods. Examples include energy commodities (crude oil and gasoline), ore commodities (precious metals like gold and silver), agricultural commodities (livestock and leather) and commodities for human use (lumber and coffee).
What is commodity trading?
While commodities are products, commodity trading represents the sale of these products in bulk. It includes, both the purchase and sale of these commodities, either through a physical trade of goods, or financial investments, such as stocks, mutual funds and futures. When investing in commodity trading, you enter a financial agreement that is handled via a regulated exchange.
Commodity trading is the foundation of our economy, representing the products that we need in our daily lives. Commodities follow standardized requirements that regulate the market and allow for fair trading.
Trading is all based on market performance; if the price goes up, you buy, and if the price goes down, you sell. For example, if you buy a product at $3 each for 120 days and the price goes down, you earn profits. If the price skyrockets, you end up losing money.
Understanding and analyzing the market can help you profit from commodity trading while diversifying your portfolio.
How do you trade commodities?
Commodity trading represents a diversified way of investing, allowing you to buy stocks, ETFs, mutual funds or even physical products. It’s all handled on an exchange, such as the Chicago Mercantile Exchange (CME)2 and the London Metal Exchange (LME)3.
This is how to trade commodities based on the different types of investments available today.
1. Physical commodities
One of the most straightforward ways to invest in commodities is to purchase the commodity itself, outright. This is common for gold as coin dealers are very prevalent, but you can trade other commodities, as well. This is a direct way of trading that does not require the involvement of a third party, saving money and skipping the complications of other investments. However, there is still the matter of delivery and storage, which is not a worry with stocks or futures.
2. Stocks
There’s also the option to purchase shares, not of a product, but of the company that manufacturers the product. Stocks are a traditional way to invest, allowing you to purchase shares in the manufacturer of a commodity. Prices are not based so much on the cost of commodities, but more on supply and demand.
There are all kinds of commodity stocks, such as mining stocks and energy stocks, making it easy to invest.
3. ETFs and mutual funds
With commodity exchange-traded funds (ETFs) and mutual funds, investors can participate in commodity trading without having to purchase goods outright. With an ETF, you have the choice of either investing in the manufacturer or investing in the actual commodity. Investors can diversify their portfolios and lower risk by investing in multiple commodities.
For additional support, investors can trade through an investment fund that can help guide trading. It’s an extra bonus that is especially beneficial to beginners to investing.
4. CFDs
A contract for difference (CFD) is a contract an investor enters into with an investment bank or firm. When the contract expires, the difference between open and closing trade prices is settled in cash. This contract allows investors to bet on price changes for a particular commodity.
This is essentially a speculative investment that bets on the price changes of a security without the need to actually buy the security itself. It’s favorable for investors because only a small amount of margin4 is required to take part in a CFD. However, CFDs are not permitted5 by the SEC within the United States.
5. Options
Options are a different form of financial contract that allow you to trade an underlying asset at a strike price or trade price. You have the option – but are not required – to participate in an options contract by purchasing that asset at a specific price. There is the option of calls or puts; while calls allow you the opportunity to buy a commodity, a put enables you to sell one.
This is a low-risk way of trading that can be highly lucrative for investors who buy and sell at the right time.
6. Futures
Futures differ from options because a purchase is required and not just allowed. With a futures contract, you agree to purchase a commodity at a set price on a future date. You profit when the spot price goes down but endure losses if it increases. Investors must maintain margin, or capital, to support trades, and the broker can make a margin call to require more capital.
Trades occur on a futures exchange and are generally used by large companies but speculative investors do participate, as well.
Commodities compared
With investments available in multiple forms, it’s important to understand the differences between each type of commodity trading. While some invest in physical goods, others invest in company shares or contracts. How you trade will determine how best to invest in commodities and where you should invest. Also, trading hours can vary significantly as seen below, so it is important to take into consideration when you plan to do most of your trading.
How to trade commodities
| Commodity |
Investment type
|
How to invest | Trading hours |
|---|---|---|---|
| Physical commodities | Physical goods | Brokerage firm, robo-advisor or private dealer | Varies based on commodity |
| Stocks | Company shares | Stock exchange via brokerage firm or robo-advisor | Generally 9:30 am to 4 pm |
| ETFs and mutual funds | Multiple securities | Brokerage firm or robo-advisor |
ETFs: 9:30 am to 4 pm
Mutual funds: After markets close at 4 pm |
| CFDs | Cash contract | International markets (banned in the US) | Varies based on country |
| Options contracts | Commodity contract | Brokerage firm or robo-advisor | 9:30 am to 4 pm |
| Futures | Speculative | Brokerage firm or robo-advisor | Generally Sunday through Friday |
How to invest in commodities
Step 1. Open an account
Before you can begin trading, you need to open a brokerage account so you can place trades. This is required if you plan to trade derivatives like futures.
Here are some of the best brokerages we recommend to help you get started with commodity trading.
If you’re an active investor or options trader looking for a way to save money on trades on commodities, you may want to check out discount broker tastytrade. This online service has some of the lowest prices around.
Acorns is an investing service and savings tool rolled into one. This micro-savings app makes investing in commodities almost painless because you're spending only pennies at a time.
Interactive Brokers offers low trading fees and robust commodity trading tools — major assets to day traders and other DIY investors. Lower-volume traders will also appreciate that they can access commission-free trading through the IBKR Lite plan.
Step 2. Choose what you want to trade
As seen here, there are a lot of options for commodity investments. You have the option of investing in the commodity directly, but that can carry extra costs like storage. You can also invest via a financial product, such as stocks, ETFs and mutual funds. CFDs are not allowed in the US.
Step 3. Choose how you want to trade
Next, you need to choose how to trade commodities. Most investors opt for an investment firm or robo-advisor so they can benefit from the additional support. However, you’ll likely incur extra fees for this service. You can also invest on your own through online or direct investing.
Step 4. Open your first position
Now that you have an account and are ready to begin investing, it’s time to open your first position. Log into your account and choose the trading market you want to use. Add funds to your account to support your investment and then make the trade.
Step 5. Track changes
Once you have made your trade, be sure to track changes in the market. This will enable you to act accordingly if you want to buy more or sell off your positions. If you are uncomfortable analyzing the market yourself, consider using a robo-advisor or financial advisor to help.
Types of commodity trading contracts
There are two main types of commodities: hard commodities and soft commodities. They each are made up of different types of products. Hard commodities are natural materials extracted from the earth, while soft commodities are those that are grown.
These are the four types of popular commodity contracts for hard and soft commodities.
Hard commodities
- Energy commodities. Energy commodities are extracted from the ground. This includes products such as crude oil, ethanol, gasoline and uranium. Renewable energy, such as wind or solar power, is also considered an energy commodity.
- Ore commodities. Ore commodities are precious metals that are mined from the ground. This includes gold, silver and platinum, as well as industrial metals like aluminum, nickel, lead and copper.
Soft commodities
- Commodities for human use. These include products for human consumption, such as sugar, cocoa and coffee. Some non-edible items for human use are also covered in this category, such as lumber and clothing.
- Agricultural commodities. Agricultural commodities are those that can be raised. This includes cattle and hogs, as well as products made from animals, such as leather and gelatine.
Commodity trading pros and cons
Commodity trading allows you to invest in multiple commodities instead of investing in a single security. Fluctuations affecting supply and demand and exchange rates can all contribute to market gains, growing your investment. You can hedge against inflation, betting that commodity trading will match the rising prices of inflation.
Of course, there are risks involved. The future of the market is never known, and there’s always the potential for losses. You risk losing your initial investment should the market perform unfavorably. That can make it especially difficult for newcomers to the market who are still learning how to trade commodities. That’s why it’s more advanced investors who generally invest in commodities, although beginners certainly invest, as well. An experienced financial advisor can help provide guidance.
Pros
-
Potential gains
-
Adds portfolio diversification
-
Can hedge against inflation
Cons
-
Easily impacted by external events, such as weather or a recession
-
Risk investment
-
May be challenging for beginners
Commodity Trading Hours
One of the benefits of commodity trading is the access. Trading hours ultimately depend on the type of investment you choose, but some are more generous than others. ETFs, mutual funds and futures generally offer more flexible hours than the stock market, and the exchange of physical commodities can take place at any time, depending on where you purchase.
| Commodity | Trading hours |
|---|---|
| Physical commodities | Varies |
| Stocks | Generally 9:30 am to 4 pm |
| ETFs and mutual funds |
ETFs: 9:30 am to 4 pm
Mutual funds: After markets close at 4 pm |
| CFDs | Varies based on country |
| Options contracts | 9:30 am to 4 pm |
| Futures | Generally Sunday through Friday |
FAQs
Lena Muhtadi Borrelli brings over 20 years of experience in the finance industry. She began her career at Morgan Stanley before transitioning over to media. As a finance writer, she has served as an authority for several respected outlets, including Forbes, TIME, Newsweek, Bankrate, Investopedia, Insurance.com, and InvestorPlace. No matter what she is writing, Lena has a unique ability to simplify complex topics, making finance more approachable and relatable to the average reader. When she is not writing or scanning the news for the latest headlines, she is happiest spending time in the Florida sunshine with her husband and two pups.
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