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For someone who has decided to begin trading on the commodity market, all the different terminology can be a little overwhelming. There are many commodity market terms that are adopted from other markets such as capital, leverage, and stop losses, but there is a whole list of terms that apply to this market specifically, so we decided to name and explain some of them to you.
The following are some of the basic terms you will encounter in the commodity market:
-Commodities: What better place to start than the beginning? What is a commodity? “A commodity is a physical substance such as food, grains, and metals that is interchangeable with another product of the same type”. Simply put, a commodity is everything you see around you. Cars are made of metal, which is a commodity, and they run on gasoline, which is a commodity. Chocolate bars are made from cocoa, which is a commodity, and they are sweetened with sugar, which is also a commodity. There are soft commodities, such as sugar or coffee, which are in the highest demand across the globe, something that obviously increases its value in the commodity market. Then there are energies, such as crude oil or natural gas, for which demand is rising. This type of commodity is affected by technological and political developments.
- Spot Market: This is a kind of transaction that accounts for a small minority of all the trades on the commodity market. To simplify things, an example of a spot trade is a basic consumer purchase of one commodity or another. So if someone were to enter a jewelry store and purchase a gold necklace for $100 cash, that is a spot trade. It is immediate and involves no risk of any kind. To avoid confusion, it is important to emphasize that spot trades are not necessarily on a smaller scale. That same consumer could have purchased several million ounces of gold, if they were representing a large scale gold factory. Oil transactions for example are sometimes also traded on the spot market.
- Future Market: The vast majority of the commodity market is traded in this manner. Instead of paying a certain amount up front, the two sides of the transaction agree on a specific future date, on which the trade will be terminated. Based on current values as well as market analysis and experts predictions, the two sides agree upon a price for which the commodity will be sold on the future date. For starters, this type of trade is different mainly because the actual commodity is not really traded, but rather a contract for a future sale is what is being transferred in this case. To explain this type of market, we will give a concrete example.
A cereal manufacturer needs corn to make their cereal, so they then approach a farmer who has grown large quantity of corn, and they agree that in two months time, the farmer will sell the company a certain amount of corn at an agreed price. If the date arrives and the price they agreed upon is higher than the value of corn, the farmer has made a profit, while the cereal company has lost money, since it could have bought corn for a lower price. If however, the price of corn is higher than the price they agreed upon, the cereal company comes away with a nice profit, while the farmer has lost money. Since the future is unknown, there is some sort of risk involved in such a trade, but unlike other markets, if the markets are analyzed properly, the risk is minimal.
These three terms are the fundamental concepts by which the entire commodity market is run. There are obviously many more terms and concepts that need to be mastered, but we thought this was a good start.
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