The commodity market is a highly popular market amongst traders. Millions of traders across the globe invest in commodities, to produce profitable returns and execute rewarding trades.
However, as with any form of trading, the commodity market comes with advantages and disadvantages, which each trader will have to weigh up before making any investments.
To better help with this process, this article will take you through what commodity trading is, and the main pros and cons of this form of trading.
What is commodity trading?
When trading commodities through financial derivatives on an expert trading platform, you are dealing with the price values of physical goods such as gas, metals, oil, and other raw materials.
Like trading on other markets, there are many different ways you can go about trading commodities. One form of commodity trading is through contracts for difference (CFDs).
Using this method, you would purchase contracts on a commodity or commodities (oil, for example) and speculate on the price movements of this particular asset(s), without owning the underlying asset.
The pros and cons
Commodity trading, whilst used by traders worldwide, comes with both its pros and cons, both of which you would benefit to understand.
- Portfolio diversification
Trading commodities is great for creating a more diverse portfolio, and this in itself comes with a range of benefits.
It’s best to diversify your investments across different markets, to ensure your losses are mitigated as much as possible. Should investments on one market fall, the others still offer potential profit.
Moreso, certain markets often move in alternate directions, impacted by different factors, and this is also true for the commodity market.
Diversification will therefore help you balance out your investment returns.
- Highly liquid market
The commodity market is one of the most liquid markets available to traders, as there are high trading volumes on the market.
With a consistent supply and demand for commodities, it is very easy to execute your trades and promptly receive your profits.
- Revolves around supply and demand
Considering commodity trading is based on the supply and demand of goods, it can prove beneficial to traders, since it allows for an easier way of monitoring and predicting market performance.
For instance, if you can identify clearly that there is high demand and low supply, you can confidently assume that the price values of those commodities will rise, making your trade speculations more accurate.
- Relies on effective leverage trading
Whilst it may act as an advantage when used correctly, the process of leverage trading with commodities can be a drawback for traders who are uninformed.
Leverage trading means you can open positions on commodity assets with higher exposure, but significantly lower initial capital.
As a result, both your profits and losses are calculated against the high exposure value, not the smaller margin you put down to open the position.
If misused, this means that failed trades could result in huge losses.
- High market volatility
The commodity market is highly volatile, which results in severe price swings and fluctuations.
To inexperienced or unprepared traders, this could result in trades taking a sudden, unfavourable turn, and throwing off your perceived idea of where the market will move.
Therefore, to trade accurately on this market, you need to carry out sufficient analysis on market performance before, during, and after each trade, to ensure you aren’t struck with the market’s unpredictability.
- Vulnerable to external factors
Commodity trading can be difficult for traders, since the market is heavily affected by external factors.
For instance, unforeseen world events such as wars, inflation rates, and natural disasters, will drastically change the performance of the commodity market.
This means, regardless of your accurate predictions, these sudden, uncontrollable events may result in trades going in an undesirable direction.
Trading commodities, like other trading instruments, requires thorough strategising and careful analysis with every trade. It’s highly suggested that you weigh up both the pros and cons, before deciding whether this market could be a worthy addition to your portfolio.