To start our journey in trading commodity CFD the first thing you need to know is what are those, so commodity CFD is a type of financial product that retail investors can buy and sell to earn profits. It deals with prices in the commodities market instead of other financial markets such as stock or foreign exchange. This type of trading is also specific to financial derivatives, particularly CFDs, instead of the primary commodity.
The commodities market entails the buying and selling of raw materials used to manufacture goods for our consumption today. The list of commodities is too long to enumerate so they are typically grouped into different categories, mainly agriculture, energy, and metals. These are some examples of the most commonly traded commodities:
• Agriculture: grains, livestock, cotton, lumber
• Energy: crude oil, natural gas, heating oil
• Metals: gold, copper, silver, platinum
Since the beginning of history, man has been exchanging these materials, whether in exchange of other goods, services or money. That makes the commodities market one of the oldest markets in the world.
CFD stands for contract for difference and it’s one of the most popular financial products today. More specifically, a CFD is a financial derivative, which means its value is derived from an underlying security. In this case, any of the listed commodities could be the underlying or primary security while the CFD is its derivative or secondary security.
A CFD is a contract between two parties, usually an investor and a CFD provider, who agree to its terms. Aside from the commodity on which to base the CFD on, these terms include the price movement of that asset. CFDs allow you to make predictions on how, say, the price of crude oil moves over a certain period of time which are indicated by the entry and exit price. If the entry price is lower than the exit price, you’re betting on the value to increase overtime. If the entry price is higher than the exit price, you’re betting on the opposite. If the market moves according to your prediction, what you earn is the difference in the price of that commodity to be paid by the CFD provider.
Commodity prices are highly dependent on several factors. Let’s use the crude oil market as an example. When trading oil CFDs, one needs to look closely at factors such as supply and demand, trade deals between major producers and consumers of oil, as well as investor sentiment.
This year has been particularly disastrous for oil as the demand dropped and, as a result, its prices. While the pandemic is ongoing, a price war between Russia and Saudi Arabia was also happening to cause further strain on the market.
On the other hand, gold prices surged as the precious metal is considered a safe haven investment. The declining dollar also contributed to gold’s rally with the two assets having displayed an inverse relationship historically.
The advantage of trading commodity CFD is the chance to profit from a declining market. For example, you can enter a contract based on the prediction that gold will continue to lose its luster as economic activity resumes and the US dollar soars. You can also do this with primary securities but a lot of experience and impeccable timing is involved in ‘shorting’ assets.
Gaining exposure in the commodities market through CFD is actually not that complicated. All you need is an account on a trading platform, some trading capital, and you’ll be well on your way to speculating and earning from the commodities market.
However, it should be noted that trading commodity CFD is not available to retail investors based in the US due to some restrictions imposed by the Securities and Exchange commission. Alternative commodity trading options available to US-based investors are stocks, ETFs, and mutual funds. Futures, however, are the most common way to get into commodity trading. To get started on trading futures, check out the day trading futures course here.