A Beginner's Guide to Trading Commodities

From coffee to crude oil, commodities are among the most actively traded markets in the world. For retail traders, the most accessible ways to trade commodities include using Contracts for Difference (CFDs) and commodity Exchange-Traded Funds (ETFs), both of which allow you to take a position without owning the physical underlying asset. 

This guide covers what commodities are, the different ways to trade them, the risks involved and how to get started.

The information in this article is provided for educational purposes only and does not constitute financial advice. Consult a financial advisor before making investment decisions.

What Are Commodities?

A commodity is a raw material or primary good that is extracted, grown or reared. Rather than being products in their own right, commodities are typically used as building blocks for other goods and services.

What distinguishes commodities from most other tradable assets is that they are fungible, meaning each unit is interchangeable with any other of the same grade. For example, a barrel of Brent crude is the same product regardless of who extracted it or where.

Commodities are typically divided into two groups:

• Hard Commodities: Natural resources that are extracted from the earth, such as gold and oil
• Soft Commodities: Goods that are grown or reared, such as coffee and cattle

Within these two groups, commodities are generally organised into four market categories:

• Energy: Crude oil, natural gas, heating oil and gasoline
• Metals: Precious metals, such as gold and silver, and base metals, such as copper and aluminium
• Agricultural: Crops grown for food or industrial use, including wheat, corn, sugar, coffee and cocoa
• Livestock: Animals reared for consumption, including live cattle

Where Are Commodities Traded?

Commodity trading primarily takes place through exchanges; the key venues include:

• CME Group (Chicago): The world's largest commodity exchange operator, incorporating the Chicago Mercantile Exchange (CME), the New York Mercantile Exchange (NYMEX), the Chicago Board of Trade (CBOT) and COMEX. Its exchanges cover energy, metals and a wide range of agricultural commodities
• ICE (Intercontinental Exchange): Operates markets for Brent crude, sugar, coffee, cocoa and cotton, with key operations in both the US and London
• LME (London Metal Exchange): The global hub for base metals trading, including copper, aluminium, zinc and nickel

Rather than accessing these exchanges directly, most retail traders will trade through a broker, using instruments such as CFDs or ETFs.

Commodity Trading Hours

Unlike stock markets, many commodity markets trade almost around the clock on weekdays. Electronic trading platforms have extended access significantly in recent years, with markets such as gold and crude oil available to trade for up to 23 hours a day.

However, exact hours do vary depending on commodity and exchange. Agricultural markets tend to have more restricted trading windows, so it's worth checking the specific hours for any market you want to trade.

Ways to Trade Commodities

There are several ways to gain exposure to commodities, with each method carrying its own level of accessibility and risk. Most retail traders gain exposure to commodities using financial instruments rather than by owning the physical commodity itself.

Physical Ownership

The most straightforward way to gain exposure might seem to be simply buying the physical commodity itself.

However, in reality, physical ownership is impractical for most traders. For starters, many commodities are traded in standardised quantities that are far beyond the reach of most retail investors. Issues such as transport, storage and insurance add further headaches.

Moreover, buying physical commodities would only allow traders to attempt to profit from rising prices. Consequently, for anyone looking to actively trade commodities, physical ownership is impractical, which is one of the reasons derivative products exist.

Futures Contracts

A futures contract is an agreement to buy or sell a fixed quantity of an underlying asset at a predetermined price on a specific future date.

They were originally developed to allow producers and buyers of commodities to lock in prices in advance and help manage the risk of price fluctuations.

However, these days, the majority of futures trading is carried out by speculators who have no intention of actually delivering, or taking ownership of, the underlying commodity. They buy or sell contracts in an attempt to profit from price movements and close their positions before the expiry date.

The price of a futures contract will typically differ from a commodity's current market price, the spot price, reflecting the cost of carry as well as expectations about future supply and demand.

Futures allow traders to go both long (buy) and short (sell), and leverage is available, which amplifies potential gains as well as losses. However, they are complex instruments and access for retail traders is significantly more limited than other investment products.

Options

An options contract gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a set price, the strike price, on or before a specified date, the expiry date.

There are two types:

• Call Options: The right to buy at the strike price; profitable if the commodity's price rises above that level before expiry
• Put Options: The right to sell at the strike price; profitable if the commodity's price falls below it

The buyer pays a premium for this right. If the option expires without being exercised, the loss is limited to the premium paid, giving options a defined downside on the buying side.

However, options contracts are among the more complex financial instruments available, particularly the way they are priced, which accounts for both time value and implied volatility. Moreover, like futures contracts, access for retail traders remains limited compared to other products.

Commodity ETFs and ETCs

An Exchange-Traded Fund (ETF) is a fund that holds a collection of assets and trades on a stock exchange like an ordinary share.

Commodity ETFs typically either:

• Track an index composed of commodity-producing companies; or
• Track the price of the underlying commodity by buying and storing the physical commodity and/or using financial derivatives such as futures.

Exchange-Traded Commodities (ETCs) are more specifically designed to follow the price of a single commodity. They can be physically backed (i.e. holding physical commodities) or synthetically replicated using derivatives.

Both are accessible through standard investment accounts and typically suit investors seeking longer-term exposure to commodities rather than short-term traders.

Commodity Stocks

Buying shares in companies that produce or mine commodities can provide indirect exposure to commodity prices. For example, a gold mining company's revenues are naturally influenced by gold prices.

However, it's important to note that a company's share price can also be influenced by a range of unrelated factors, such as costs or management decisions. Consequently, the relationship between a company's share price and the commodity it works with can vary considerably.

Like ETFs and ETCs, commodity stocks are accessible through investment accounts and may be more suitable for those seeking longer-term exposure.

CFDs

A Contract for Difference (CFD) is an agreement between two parties to exchange the difference in the price of an underlying asset between the point the trade is opened and the point it is closed. Traders using CFDs never have to deliver or take ownership of the underlying asset.

Commodity CFDs allow traders to go both long and short, and are traded using leverage, allowing traders to access larger positions with a smaller deposit. However, whilst leverage magnifies potential gains, it also has the same magnifying effect on losses and so must be used responsibly.

CFDs are complex instruments, which might not be suitable for everyone. However, in Europe, they tend to be more accessible to retail traders than the other derivative products we have examined.

How Commodity CFD Trading Works

The profit or loss of a CFD trade can be calculated using the following formula:

(Closing price − Opening price) × Contract size = Profit or loss

For a short trade, the formula would be reversed:

(Opening price − Closing price) × Contract size = Profit or loss

Example: Going Long on Brent Crude Oil

Let's say, following research, a trader believes the price of Brent crude oil is likely to rise, so they open a long position using Brent CFDs.

• Commodity: Brent crude oil
• Contract size: 1 lot = 100 barrels
• Opening price: $93.00 per barrel
• Total position value: $9,300
• Leverage: 1:10
• Margin required: $930

Rather than committing the full $9,300, the leverage available means the trader would only need $930 in their account to open this position.

If the trade goes in their favour:

The price rises to $100.00 per barrel and the position is closed.

($100.00 − $93.00) × 100 = $700 profit

If the trade goes against them:

The price falls to $85.00 and the trader closes their position.

($85.00 − $93.00) × 100 = $800 loss

This illustrates a key characteristic of leveraged trading; whilst leverage amplifies potential profits, it amplifies potential losses to the same extent. Moreover, if the market moves against you, it can potentially result in losses that exceed your initial margin.

CFD Trading Costs

The figures above do not account for trading costs, which will have an impact on the outcome of every trade. The main costs associated with commodity CFD trading are:

• Spread: The difference between the buy (ask) and sell (bid) price of an instrument. Essentially, this is the amount your trade has to move before it potentially becomes profitable.
• Swap: If a position is held open past the market close, an overnight financing charge is applied. Depending on the underlying asset, the direction of the trade and prevailing interest rates, this can be either a charge or a credit.
• Commission: Some brokers charge a per-trade commission in addition to the spread, whilst others operate on a spread-only basis.

What Moves Commodity Prices?

Like any freely traded good, commodity prices are driven primarily by supply and demand, both of which can be significantly affected by a range of factors.

Supply and Demand

The fundamental driver of any commodity price is the balance between supply and demand. When demand outweighs supply, prices rise; when supply outstrips demand, prices fall.

What makes commodities particularly sensitive to this is that supply is often slow to respond to price changes. A new mine can take years to become operational; similarly, a crop takes months to grow and harvest. This lack of flexibility means that even relatively small disruptions to supply or sudden shifts in demand can trigger significant price moves.

Geopolitics

Because many of the world's most important commodities are concentrated in specific regions, geopolitics can have an outsized effect on prices.

The Russian invasion of Ukraine in 2022 is a clear example. Ukraine is one of the world's largest exporters of wheat, corn and sunflower oil, whilst Russia is a major energy producer. The war triggered sharp price spikes across global energy and agricultural markets as supply chains were disrupted.

Weather

Agricultural commodities are particularly sensitive to weather, which naturally plays an important role in production.

Ideal weather conditions can lead to a bumper crop, which can weigh on prices as supply outstrips demand. On the other hand, adverse weather conditions can damage crops, leading to shortages and rising prices.

For example, in 2023 and 2024, prolonged dry conditions in West Africa significantly hampered cocoa production, sending the market to record highs as cocoa prices tripled.

On the demand side, the price of energy commodities can also be affected by weather conditions. Severe winters can cause an increase in demand for energy for heating purposes, whilst an unusually hot summer may also drive an increase in electricity consumption.

The US Dollar

Commodities are priced in US dollars in international markets, which creates a direct relationship between the USD and commodity prices.

When the USD weakens, commodities become cheaper for buyers using other currencies, which can support demand and push prices higher. When the dollar strengthens, the opposite applies.

Substitution

As the price of one commodity rises, buyers may switch to a cheaper alternative where one is available. This reduces demand for the original commodity, which may halt, or even reverse, rising prices.

For example, thanks to its excellent conductivity, copper is widely used in electronics and the renewable energy sector. If copper prices get too high, some manufacturers may switch to aluminium as a cheaper alternative, reducing demand for copper and potentially weighing on prices.

Economic Health

The health of the global economy can also have a significant impact on commodity demand.

A growing economy tends to drive demand for commodities, as industrial activity and construction increase and consumers spend more. On the other hand, a slowdown or recession typically weighs on demand.

Again, copper is a good example of this and is often viewed as a reliable indicator of economic health, earning it the nickname “Dr Copper”. Because of its extensive role in construction and manufacturing, demand tends to rise when the economy is growing and fall when the economy slows or contracts.

Why Do Traders Use Commodities?

Commodities attract different types of market participants for different reasons. Retail traders, institutional investors, producers and consumers all interact with commodity markets, but their reasons for doing so vary considerably.

Speculation

For most retail traders, the primary motivation is speculation, which involves attempting to profit from movements in price. Commodities can be highly volatile, creating plenty of potential trading opportunities in both directions.

Inflation Hedging

As prices rise, the purchasing power of money declines. Because commodity prices tend to rise alongside inflation - indeed, raw materials are themselves a key driver of consumer prices - investors may use commodities to hedge against rising prices.

Gold has the strongest reputation as an inflation hedge, with the precious metal typically viewed as a long-term store of value.

Portfolio Diversification

Historically, commodities have demonstrated a fairly low correlation with traditional investments. In other words, their prices do not always move in the same direction.

This means that when stocks or bonds are falling, commodity prices may follow a different trajectory, holding their value or even increasing.

This low correlation is one reason investors might include commodity exposure alongside stocks and bonds. It does not eliminate risk, but it may reduce the overall volatility of a portfolio by holding assets which respond to the same market environment in different ways.

Hedging

Many of the largest participants in the commodity markets are there to hedge against adverse future price movements rather than profit from them.

For example, a farmer faces the risk that prices will fall before they harvest their crop. Instead of taking that risk, the farmer may choose to trade commodity futures, locking in a guaranteed price for their crop regardless of what happens in the intervening period.

The trade-off is that if prices rise significantly, they will not benefit from the upside. But for a producer who wants certainty for their business, that may be an acceptable compromise.

On the other side, many buyers also use the same principle to manage input costs. For example, many airlines hedge against future movements in jet fuel prices.

How to Start Commodity Trading

The following steps outline what to do and consider before placing your first commodities trade.

1. Choose Your Commodity and Method

Energy and metals markets tend to be the most liquid and actively traded, which may make them a natural starting point for beginners.

In terms of method, CFDs are widely available for retail traders; however, like other derivatives, they are complex instruments which may not be suitable for everyone.

Furthermore, CFDs tend to be more suited to traders speculating on short-term price movements. Stocks and ETFs may be more suitable for long-term exposure without the added complexity and specific risks associated with leveraged instruments.

2. Open a Trading Account

Practising on a demo account, which many brokers offer for free, before committing real capital allows you to familiarise yourself with a platform and better understand how commodity markets behave without risking any money.

When ready, you will need to open a live account with a regulated broker in order to access the live markets. Among other things, it's worth checking the available markets and the costs of trading before opening an account.

3. Analyse the Market

Most commodity traders draw on one or both of the following approaches analysing the market.

• Fundamental analysis involves examining the real-world factors that drive commodity prices.
• Technical analysis involves studying price action and using indicators to identify patterns and trends, as well as potential entry and exit points.

Many traders use a combination of both; fundamental analysis to identify which direction a market is likely to move, and technical analysis to pinpoint their entry and exit.

4. Manage Risk

Risk management is an important part of any approach to the financial markets, particularly when trading derivatives such as CFDs. Leverage increases the risks of commodity CFD trading, potentially leading to rapid losses if the market moves against you.

A few principles worth building into any trading plan:

• Position Sizing: Limiting the amount risked on any single trade helps ensure that no single loss is catastrophic.
• Stop Losses: An instruction to close a trade automatically if the price moves against you by a predetermined amount.
• Trading Plan: Predefining your criteria for entry and exit, and maximum risk can help keep decision-making rational.

5. Place and Review Your Trade

When placing a trade, you will typically have the option of a market order, which executes immediately at the next available price, or a limit order, which is only triggered if the price reaches a level you specify. Most platforms will also allow you to set stop loss and take profit levels at the point of entry to help with your risk management.

Once a trade is closed, reviewing the outcome is a valuable part of developing as a trader. Analysing the result of the trade and your own actions can help refine your approach over time.

Other Articles You Might Be Interested In:

• European Defence Stocks
• What Is a Bear Market
• UK Blue Chip Stocks Explained

INFORMATION ABOUT ANALYTICAL MATERIALS:  

The given data provides additional information regarding all analysis, estimates, prognosis, forecasts, market reviews, weekly outlooks or other similar assessments or information (hereinafter “Analysis”) published on the websites of Admirals investment firms operating under the Admirals trademark (hereinafter “Admirals”) Before making any investment decisions please pay close attention to the following:  

• This is a marketing communication. The content is published for informative purposes only and is in no way to be construed as investment advice or recommendation. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead of the dissemination of investment research.  
• Any investment decision is made by each client alone whereas Admirals shall not be responsible for any loss or damage arising from any such decision, whether or not based on the content.  
• With view to protecting the interests of our clients and the objectivity of the Analysis, Admirals has established relevant internal procedures for prevention and management of conflicts of interest.  
• The Analysis is prepared by an analyst (hereinafter “Author”), with the assistance of AI tools. The Author Roberto Rivero is a contractor for Admirals. This content is a marketing communication and does not constitute independent financial research.  
• Whilst every reasonable effort is taken to ensure that all sources of the content are reliable and that all information is presented, as much as possible, in an understandable, timely, precise and complete manner, Admirals does not guarantee the accuracy or completeness of any information contained within the Analysis.  
• Any kind of past or modelled performance of financial instruments indicated within the content should not be construed as an express or implied promise, guarantee or implication by Admirals for any future performance. The value of the financial instrument may both increase and decrease and the preservation of the asset value is not guaranteed.  
• Leveraged products (including contracts for difference) are speculative in nature and may result in losses or profit. Before you start trading, please ensure that you fully understand the risks involved.