How to Trade Cotton CFDs
Cotton has been a staple in the textile industry for many years. In fact, there is evidence that cotton was being grown and woven into cloth over 5,000 years ago. Although its use in clothing has fallen in recent years due to the emergence of substitutes, cotton is still a multi-billion dollar industry and is one of the most traded commodities in the world.
In this article, we will take a look at cotton trading, discuss what factors can alter its price and explain how to trade cotton Contracts for Difference (CFDs).
Table of Contents
Cotton Trading – The Different Methods
Before we look at what affects cotton prices and how to trade cotton in more detail, let’s take a quick look at the different ways of trading cotton.
Due to the logistical issues presented from buying the physical commodity – such as storage and transportation – cotton trading is mainly conducted through the use of financial derivative products. Derivative products, as the name suggests, derive their value from an underlying asset, and allow traders to speculate on its price without ever taking ownership of, or delivering, the asset in question.
There are a number of different types of financial derivative products, in the following sections, we will look at two of the most popular when it comes to trading cotton: cotton futures contracts and cotton CFD trading.
Trading Cotton Futures
A futures contract represents an agreement between two parties to exchange an underlying asset at a predetermined price on a fixed date in the future.
As well as being used to hedge risk against adverse future movements in an asset’s price, futures are also widely used by speculators, who buy and sell contracts in an attempt to profit from price movements without ever taking or delivering ownership of the underlying asset.
Futures contracts are bought and sold on futures exchanges, they are heavily regulated and all contracts are standardised for quantity and quality. For example, cotton futures trade on various exchanges, including the Intercontinental Exchange, with contracts set at 50,000 lbs.
Cotton futures can be traded on margin, however, the large contract sizes can be off putting for less experienced traders. Furthermore, the fact that cotton futures have an expiry date limits the amount of time traders can hold a position before being forced to roll the contract over to a further out month.
Cotton CFD Trading
Contracts for Difference (CFDs) represent an agreement between two parties to exchange the difference in an asset’s current price and its price at the time the contract is closed. Unlike futures, CFDs can only be used for speculation, with no assets ever changing hands.
Cotton CFD trading allows traders to attempt to profit from both rising and falling prices, whilst also providing easy access to leverage. However, leverage should always be used with extreme caution, as it has the effect of magnifying losses as well as profits.
CFDs typically offer the option of smaller contract sizes than futures contracts. Moreover, with cotton CFD trading, there is no expiry date at which point the contract needs to be closed – provided the trader has sufficient margin in their account. However, traders do need to be aware of the swap fee, which is an interest rate charged on positions left open overnight.
What Affects Cotton Prices?
The price of cotton is determined by global levels of supply and demand, which in turn can be influenced by different factors, some of which we will look at in this section.
When trading an agricultural, or soft, commodity such as cotton, it helps to be aware of the countries where production is taking place. If production is concentrated in a handful of countries, we should pay particular attention to these locations when trading cotton.
In the 2021/2022 season, India, China, the US and Brazil accounted for around 70% of total global production. These figures tell us that any events which disrupt the supply chain in these countries could have a significant impact on the global supply and, therefore, cotton prices.
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As with every soft commodity, weather plays a key role in production. A season with adverse weather can destroy crops, hindering production and leading to a rise in prices.
On the other hand, ideal weather conditions can lead to a bumper crop, increasing global supply and, subsequently, causing prices to fall.
For example, in 2021 and the first half of 2022, a series of extreme weather events in the US, India, China and Brazil combining to threaten global supply. Consequently, cotton prices soared to their highest level in more than a decade.
The process of farming cotton is expensive and a large part of production costs come from the cost of running machinery and motor vehicles essential to the farming process.
Machines, equipment and vehicles are all powered using fuel meaning that the price of crude oil can have a direct impact on the production costs and, therefore, price of cotton.
Because of this, the price of crude oil and the price of cotton tends to be positively correlated.
As with all trade, international relations can play a role in determining the global price of cotton. Of particular importance is the relationship between China and the US, two of the world’s largest producers of cotton.
This is due to the fact that, as well as being a major producer of cotton, China is also both the world’s largest importer of cotton. The US, on the other hand, is the world’s largest exporter of cotton and China imports a lot of its cotton from the US.
Particularly relevant in this case is the United States’ recent restrictions on cotton, or goods using cotton, which has been produced in China’s Xinjiang region, which accounts for the bulk of China’s cotton production.
How to Trade Cotton CFDs
With Admirals, it is possible to trade CFDs on cotton and cotton futures! In order to start cotton CFD trading with Admirals, follow these steps:
- Open a Trade.MT5 account
- Log in to your Dashboard account
- Find your account details and click ‘Trade’ to open our Native Trading portal
- Click ‘Search’ on the left of the screen and search for cotton and click the symbol to open a price chart
- On the right of the screen, choose whether you want to buy or sell and enter a position size to open a position
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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.