The Fundamentals of Commodity Trading

By: Hillel Fuld
Commodities trading, much like Forex, and other markets, tends to seem like a complicated and highly technical field to the inexperienced trader. It is true that the depths of commodities trading are endless, and there is always more to learn. However, what most people do not realize is that they know more about commodities trading then they think.

Almost all resources one encounters in their day to day life falls under the category of commodities. Walk down an average aisle in your local supermarket, and you are likely to see a great percentage of the world’s “soft” commodities. To name a few examples of commodities we are all familiar with, rice, cocoa, wheat, and coffee are just some that come to mind.

The other type of commodities that surround us daily are “hard” commodities, which include the metal used to build our cars, as well as the staples that construct every piece of electronic hardware we use. Look around you, almost anything you see is or includes one of the world’s basic commodities.

Not only are most average people aware of the existence of these commodities, they are also quite knowledgeable about the market in which they are traded. Take gasoline for example. Who has never carried out a conversation about the price of gasoline and how you used to be able to fill up a car for so much less? Who has not speculated about the cause of this fact, and what the future brings? These are all topics most people think about it at one point or another, and these are the exact topics that drive the commodities market. This is what people mean when they say commodities trading.

So now that we established that we are all familiar with the basic commodities, how do these substances and resources become a part of our daily lives? How do they transform from a natural resource to a pricey and sought after commodity?

The basic principle that drives the commodities market is commodities futures trading. You have probably heard the words futures or future trading mentioned before, but what does it mean? It refers to the transaction in which two sides agree on a set price of a certain commodity, based on expected trends and developments.

A future is “a financial contract to buy or sell a specified amount of a product or financial instrument at an agreed price on or before a given date in the future”.
To give a more concrete example, a farmer might sell his crop months before harvest, which would provide the benefit of receiving a set price, irrelevant of future climate conditions, which might otherwise have lowered the price.

So where does that risk disappear to? What happens if there is a hurricane and the crop is destroyed? Well, that risk is assumed by the buyer, but not out of the kindness of his heart. In exchange for assuming that risk, the crop is sold for a lower price then what is assumed the actual value will be on the future date. The closer we get to the date, the lower the risk, and the higher the price of the commodity, which thereby provides a return for the buyer.

Generally speaking, what drives the commodities market or commodities trading is global economic growth. The more the economy advances, the higher the demand for commodities. The trends of the global economies are predicting that more people are moving into cities and benefiting from advanced technologies. This increases the need for infrastructure, water, housing, offices, factories, and transportation, which all lead to the increased need for commodities and more active commodities trading