How to Create Commodity Trading Strategies
Traditionally, trading commodities was a slightly complicated affair and only available 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 and explain step by step how to create 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 to gold.
To find out more about the different ways of trading commodities and how you can get started, check out our other article: “How to Start Commodities Trading”
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 commodity trading strategy that will be successful for every type of commodity.
Therefore, it is down to you to formulate your own commodity trading strategy for the particular asset you intend to trade and which suits your personal trading style. 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 have the best chance of successfully trading commodities, it’s a good idea to incorporate 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 freely traded goods, the prices of commodities are governed by 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, people consume more of everything, driving up demand for many 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 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.
There is one exception; a commodity whose demand is often 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, many investors shy away from riskier investments and instead put their money into safe haven assets, such as gold.
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 natural 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. Often, 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.
If the majority of a commodity’s supply is concentrated in one location, the more sensitive it will be to the factors above.
Fundamental Commodity Trading Strategies
Now that you know some of the different factors that influence the price of commodities, you could decide to build commodity trading strategies out of this information.
For example, imagine you heard about adverse weather in the Colombian coffee region which might ruin the harvest. From this information, you could predict that the global supply of coffee could fall and, therefore, prices could rise. 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 Strategy
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.
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 expert trader Markus Gabel provides an in-depth introduction to the subject!
You may now be ready 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 and be aware of these drivers so you are not caught off guard whilst trading.
It is also always recommendable to practice any new commodity trading strategy on a demo trading account before taking it into the live markets.
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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.