An Introduction To Trading Commodities

Commodities are physical goods that metals like gold, silver and copper, energies like oil and gas, agricultural goods, like cotton and grains, and soft, which includes goods like coffee, sugar and cocoa.

Most traders trade commodities with derivatives, which are contracts like options, futures, swaps and CFDs, that represent an agreed measurement of a certain commodity concerned.

A CFD, or contract for difference, is a derivative that enables a trader to profit on the commodity prices as they go up and down. A CFD states that the trader must exchange the difference in price between the time at which the contract is entered, and the time it is closed.

So, if gold was trading at was $1,600 an ounce and you thought it would rise, you could enter a long position on gold with a CFD contract. You buy a CFD, representing 100 ounces of the yellow metal, and the price climbs to USD1,625. Your gross profit is $25 an ounce, or USD2,500 in total (this figure doesn't include trading spreads, interest and other fees).

There are several advantages to trading gold through a derivative contract, like CFDs, rather than investing in it outright. The first advantage is that holding the metal itself necessitates storage and security, and it can also be difficult to sell quickly, if you need.

The second positive is that derivatives allow you to use leverage. Leverage (or gearing) is essentially borrowing to increase the size or your position in the market and, consequently, magnify your potential profits relative to your initial deposit.

Therefore, if your CFD provider offers 20:1 leverage, you could access a position twenty times larger than if you had invested conventionally.

For instance, if you invested USD5,000 in oil and the price of oil rose by 3 per cent, your resulting profit would be $50. On the other hand, had you an oil CFD on a 5% margin, you could open a $100,000 position for the same $5,000. When the price of oil rose by the same 3 per cent, your gross return would be USD3,000, a 60 per cent return on your initial deposit of $5,000.

Please keep in mind, however, that as CFDs are a leveraged product, they exaggerate losses to the same extent as your profits. Consequently, traders may lose more than their original investment.

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