What is Commodities Trading?

Posted On December 4, 2021December 14, 2021

Posted By Desiree Nance

The word “commodities” is derived from the Latin Commodus, which means “appropriate, fit, proper”. A commodity in its original sense was any object of trade. Today, the term is used for economic goods or services bought and sold on a market, such as cotton, wheat, oil, gold, and silver. There are many different types of commodities with varying degrees of liquidity (marketability) depending on the type of market in which they are traded. However, it is also defined as materials used in manufacturing goods, the goods themselves, the things you might find in a store.

This definition alone can cause some confusion when defining what exactly qualifies as a commodity because each item will have its market value that can often fluctuate in a short period. Other examples of commodities are public securities, currency, stocks and bonds, raw materials used to manufacture other goods, livestock, grains, and oilseeds.

What is a commodity trade exchange?

A commodity trading exchange is no different from any other exchange because it is an intermediary between buyer and seller with which buyers and sellers can trade their products or assets for profit. However, unlike stock exchanges, commodities exchanges also offer futures contracts on top of spot prices, meaning investors can make larger gains if they predict price movements correctly.

The emergence of electronic markets

Market traders establish the market price through statistical analysis while arbitrageurs seek out the price discrepancy between markets making physical delivery unlikely due to transportation costs. This has made it easier for electronic markets to be created.

As technology continues to grow, so does its use in trading commodities, which complicates the simple definition of what actually constitutes a commodity itself. With each new type of investment introduced, more challenges are created for regulators and investors alike.

It is important to understand that there is no one singular way of defining commodities. What can be agreed upon is that any product bought and sold on the market qualifies as an exchange-traded good, whether physical or otherwise.

What are the risks associated with commodities trading?

Commodities such as gold and silver and more obscure options like cocoa and aluminium can be bought and sold just like stocks or currency on companies that trade in those items. Compared to other financial instruments, these trades tend to offer riskier but more lucrative returns on investment. For example, if an investor buys 10 ounces of gold for 1,000 dollars today, it may be worth $1,500 tomorrow, which is a return of 50%.

Now, if that same person were to buy a stock option with the same amount of money, it might be worth $1,000 in a day or two, which is only 10% profit. While this risk may seem appealing to some, it can cause great financial problems for others. After all, trading commodities is just like gambling at a casino, and the house always wins.

The first risk associated with trading in these markets is liquidity. This means how easy it is to turn your investments back into cash in order to stop trading when desired or needed. It can be very difficult to sell commodities in the market, especially if there are no buyers available.

The subsequent risk associated with trading in commodities is credit. Because companies offering these services are not banks, they can’t give you an actual line of credit for the cash required to buy the commodity you want. Instead, what they will do is allow you to trade with part of your investment and keep some cash on hand instead of using all your funds upfront like traditional savings accounts offer. That way, if prices drop right away, you’ll still be able to get your money.