How to Create Commodity Trading Strategies
Commodities offer diversification for an investor’s portfolio, which reduces exposure to any one financial market and, therefore, is important in helping to manage risk. Traditionally, trading commodities was a more complicated affair and available only to professional traders. However, with advances in technology and, with it, the evolution of online trading, commodity trading is more accessible than ever before.
In this article, we will explain what commodities are, tell you the different methods of trading them and explain step by step how you can construct your own commodity trading strategies!
Table of Contents
What Is Commodity Trading?
Commodities are either raw materials or agricultural products which are generally used as the “building blocks” for other goods or services. Therefore, the term commodity covers a vast range of goods, from sugar to crude oil, from coffee beans to gold.
Commodities of the same quality tend to be fungible with one another. In other words, they are interchangeable and of the same value to consumers.
For example, sugar produced in India will have the same value as sugar produced in Brazil. Provided the commodity is of the same quality, consumers will not usually distinguish between the two.
How to Trade Commodities
Commodities are real, tangible assets which can be bought and sold. Naturally, buying and storing these physical assets in large enough quantities to sell for profit would present logistical difficulties for the majority of traders.
Luckily, there are many other ways for people to trade commodities without ever having to take physical ownership of the commodities themselves. Below we have listed some of the most common methods available for trading commodities:
- Futures Contracts
- Contracts For Difference (CFDs)
- Exchange Traded Funds (ETFs)
- Spread Betting
Each of these financial products comes with a list of their own advantages and disadvantages, providing you with a lot of choice about the best way for you to trade commodities.
At Admirals you can trade commodities via stocks, ETFs and CFDs!
How to Create Commodity Trading Strategies
Given the vast array of goods incorporated in the term ‘commodity’ and the different ways of trading them, it is not possible to provide an all-encompassing trading strategy that will be successful on every type of commodity.
The type of commodity trading strategy you choose will also depend on what type of trader you are. Commodity trading strategies that work for a day trader may not work for a swing trader.
Therefore, it is down to you to formulate your own commodity trading strategy for the particular asset you intend to trade. However, we will provide you with some ideas on how to get started!
Commodity trading strategies are usually based on either technical analysis, fundamental analysis or a mixture of the two. In order to succeed in trading commodities, you should use some form of fundamental analysis, as commodity prices tend to be sensitive to global events.
In the following section we will take a look at some of the factors which can influence the price of commodities, to help you understand the fundamental side of commodity trading strategies.
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What Affects the Price of Commodities?
Like all other goods, the prices of commodities are governed by the global levels of supply and demand. Decreases in supply and increases in demand both tend to put upwards pressure on prices. Conversely, prices will most likely fall when supply increases and/or demand increases. But what factors affect supply and demand for commodities?
Health of the Economy
The relationship between economic growth and commodities is more or less as you would expect. When the economy is growing strongly, people consume more of everything, driving up demand for commodities and in turn pushing up their prices.
This is true for commodities that are consumed, like rice and coffee; and for so called industrial commodities - commodities like copper and iron that are widely used in the manufacture of other products.
The opposite is also true - when the economy is weak and people are earning less, or fear losing their jobs, then consumption of commodities like sugar and coffee will decline - as will manufacturing and, thus, the demand for industrial commodities.
Depicted: Admirals MetaTrader 5 - Copper Daily Chart. Date Range: 12 March 2019 - 5 July 2021. Date Captured: 5 July 2021. Past performance is not a reliable indicator of future results.
There is one exception; a commodity whose demand is expected to stay the same or, sometimes, increase during times of economic turmoil. That commodity is gold.
Gold is what is known as a safe haven asset. In other words, in times of financial turbulence, people will shy away from other investments and put their money into safe haven assets, such as gold.
Depicted: Admirals MetaTrader 5 - Gold Daily Chart. Date Range: 19 March 2019 - 5 July 2021. Date Captured: 5 July 2021. Past performance is not a reliable indicator of future results.
For agricultural, or soft, commodities, such as coffee and rice, weather conditions can play a large part in determining price.
Adverse weather can damage annual crops or even production facilities, denting supplies and increasing prices. Of course, the opposite can also be true; sometimes ideal weather conditions result in bumper crops which flood the markets and reduce prices.
Furthermore, severe weather, either hot or cold, can also affect the demand for heating or air-conditioning, increasing or decreasing prices for oil and gas.
The US Dollar
Most commodities are produced outside the US but priced in US dollars for the international market. When the dollar rises, commodity prices tend to fall, when measured in dollars.
This is because when the US dollar rises, commodities become more expensive for non-dollar consumers. Therefore, consumption of these commodities will fall, which will lead to prices also falling.
The opposite of all this is also true - when the value of the dollar falls, the price of dollar-denominated commodities will tend to rise.
Wars, strikes, demonstrations - anything that disrupts the production of a commodity, or its transportation, can lead to an increase in prices. Sometimes just the threat of these events can have the same impact.
Earthquakes, hurricanes, fires, floods and any other natural disaster can impact commodity prices if it disrupts production, production facilities or transportation.
The more concentrated the supply of a commodity is (copper in Chile or oil in the Middle East) the more sensitive it will be to many of the factors above.
Fundamental Commodity Trading Strategies
Now that you know some of the different factors that influence the price of commodities, you might decide to build commodity trading strategies out of this information.
For example, imagine you heard about adverse weather in the Colombian coffee region which was likely to ruin their harvest. From this information, you could predict that this is likely to reduce the global supply of coffee and, therefore, raise its price. This might prompt you to take a long position in the coffee market.
There are many different scenarios where you can use information about what affects the price of commodities to your advantage within a commodity trading strategy. A good way to keep up with information which might be important, is to use an economic calendar.
Technical Commodity Trading Strategies
To some people, trading solely using fundamental analysis is not appealing. In this case it is possible to just be aware of any fundamental events which could affect your profits, but instead use commodity trading strategies which generate trading signals by using technical indicators.
One such indicator is the CCI (Commodity Channel Index). Despite its name its use is not limited solely to commodity trading strategies!
The CCI indicator is an indicator which measures the strength behind a price movement by comparing the current price to the average price over a specified period of time. It oscillates either side of zero, spending most of its time between 100 and –100. When the value breaks out of this range, it signifies strength or weakness respectively in a price movement.
A very simple commodity trading strategy might choose to buy an asset once the indicator crosses above the +100 line and sell when the indicator crosses below the -100 line.
Depicted: Admirals MetaTrader 5 – Cotton Daily Chart. Date Range: 20 March 2020 – 27 May 2021. Date Captured: 5 July 2021. Past performance is not a reliable indicator of future results.
Of course, this is just one example of a simple commodity trading strategy using technical indicators and not an endorsement.
There are a whole range of other technical indicators which you could use to construct commodity trading strategies yourself.
If you want to learn more about trading commodities, you can watch the webinar below, where professional trader Markus Gabel provides an in-depth introduction to the subject!
You should now stand in good stead to start creating your own commodity trading strategies. Remember, once you have decided which commodity you want to trade, research what drives the global supply and demand of that commodity. Be aware of these drivers so you are not caught off guard whilst trading.
It is always recommendable to practice any new commodity trading strategies on a demo account before taking it into the live markets.
Trade Commodity CFDs with Admirals
With a Trade.MT5 account from Admirals you can trade CFDs on a variety of different commodities, including crude oil, gold, silver, coffee and many more!
CFDs allow traders to benefit from leverage, as well as being able to take advantage of both rising and falling prices in the commodity market. Click the banner below to start using commodity trading strategies with CFDs today!
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.