Commodities are commercial goods that are considered interchangeable with other goods of the same kind and quality, and traded in that fashion. When most people think of commodities, they may think of traditional commodities such as wheat, cattle, heating oil or gold. Today, this definition can also include financial instruments such as currencies or indices, but the approach in trading commodities is the same for all of these options.
The main categories of commodities are:
- Agricultural - Including traditional US crops such as wheat, corn, and soybeans — as well as imported crops such as coffee, sugar and cocoa. Rice, cotton and any other non-animal based agricultural crop goes in this category — as well as frozen concentrated orange juice for fans of the movie, Trading Places.
- Livestock and Meats - Including lean hogs, live cattle and feeder cattle, as well as meats such as pork bellies.
- Energy - Including gasoline, heating oil, grades of crude oil, natural gas, and propane.
- Metals - Most people think of precious metals such as gold, silver, platinum and palladium, but industrial metals such as copper, nickel, zinc and cobalt are also included.
Before you invest in commodities, define your goals for investing and how much money you are willing to risk. Commodity markets vary and are often quite volatile and unpredictable — many are susceptible to unplanned events such as natural disasters and man-made disruptions like political instability in oil-producing countries. Although understanding of your chosen commodity makes it more likely to profit, lack of understanding makes losses likely and turns your investment into a figurative trip to the casino (with worse odds).
Once you decide commodities are for you, you will need to choose a broker. Options range from full-service brokers with individual advice and assistance to no-frills discount brokers who give you the means to facilitate your trades but little else. As usual, greater service equals higher cost. Investigate any broker thoroughly before committing.
Your skill and comfort level dictates what you should be looking for in a broker. If you are a novice, full-service brokers are worth the investment — assuming they are skilled traders. You should focus on their past results. If you are comfortable with taking the risks yourself, your primary goal is to find favorable fees/commissions and the most efficient trading platform. Approach any high-pressure sales tactics with caution.
Next, you will need to open an account. The broker will require a minimum account deposit and account balance. Typical minimums are $5,000 and may be as low as $1,000, but you are likely to need in the range of $10,000 to make meaningful trades and avoid losses dropping your account below your minimum balance. If the broker has concerns about your financial standing or creditworthiness, he or she may refuse your business.
Typical commodities exchanges are carried out as futures contracts (where parties agree to a transaction at a future date at a set price). Exchanges such as the Chicago Board of Exchange define the quantity, grade or quality, and other conditions regarding the trade. You may choose options to lower the risk. Options are the right to buy or sell a commodity at a particular price, whereas futures contracts are legal obligations.
These trades may be highly leveraged, with a relatively small investment controlling a contract covering a large amount of goods. Changing prices may cause disproportionate amounts of money to be made — or lost — with great speed. So start with caution and avoid the thrill of overtrading. It is easy to lose in commodities if you are trading so fast that you cannot assess your total gains and losses at any point in time.