CFD Commodity Trading

Contract For Difference (CFD) commodity trading allows for investors to bid on the changes in the value of particular commodities. CFDs do not require the trader to own the commodities themselves, only the difference from the initial price is exchanged between the broker and investor when the trade is complete. This article will discuss what commodities are, what CFD commodity trading is, what to look out for and the best online brokers.

What Are Commodities?

A commodity is a physical good that is usually a natural resource. Commodities of the same type are considered (almost) equal, no matter who produced them.

Goods and commodities that are fungible are not differentiated by brands or quality and their prices are determined by the performance of the market as a whole, closely following supply and demand.

Examples of goods that are used for CFD commodity trading are precious metals, oil and agricultural goods like rice.

Hard Commodities

Hard commodities are defined as those that are mined or extracted from the earth, i.e. natural resources that are not renewable. These are generally the most popular for CFD commodity trading and can be categorised into the following:

Metals

Metal commodities include gold, silver, copper and platinum. These metals are used in a variety of applications, such as jewellery (gold, silver), electronic wiring (copper) and other industrial uses (platinum, copper, silver etc.). Precious metals are, at times, invested in due to their reputation of being reliable stores of value, which can provide stability to some during periods of extreme market volatility.

Energy

Energy commodities consist of resources such as oil, natural gas, gasoline, etc. These commodities can also have other applications such as the production of plastics (oil), transportation (gasoline) and generating electricity (gas). Instability in this commodity market was seen during the COVID-19 pandemic, where the price of oil drastically fell due to the decrease in demand. Geopolitical factors can also influence the price of oil, particularly the policies of OPEC (Organisation of Petroleum Exporting Countries).

Soft Commodities

Soft commodities are defined as those that can be grown and cultivated, i.e. renewable resources. As such, the prices of these commodities are often more volatile, depending on external factors like climate and other environmental conditions. This has led to less popularity for CFD commodity trading than hard commodities, though investors with a large risk appetite may prefer these.

Agriculture

Agricultural commodities are natural resources like wheat, rice, coffee and corn. These are used as sources of food for both people and livestock, as well as the production of other products. It is common for the price of these goods to be heavily impacted by periods of turbulent weather, population growth and natural disasters.

Why Are Commodities Suitable For CFD Trading?

The price of commodities is affected by the concept of supply and demand. If there is more demand for the good than supply, then the price of the commodity increases, and vice versa. The growth of large economies like India and China has led to increases in the demand for various goods, such as metals and energy. Additionally, recent changes in the economic climate due to the pandemic have further impacted the rise and fall in the value of various commodities, making CFD commodity trading appealing given the ability to both buy long and sell short on these market variations.

Pros & Cons

Key takeaways that you should keep in mind about why CFD commodity trading could be beneficial to you are:

• You only need to deposit a small percentage of the full commodity value (usually around 5-10%) to open your position on the market through the use of margin trading.
• Traders can take a position on an increase in value of a commodity without having to physically purchase and take ownership of it.
• You can “short” a commodity if it is going down in value, allowing you to trade during bearish markets.

However, there are negatives that you should be aware of and understand before CFD commodity trading:

• You will never own the underlying commodity when trading with CFDs.
• Although the profits could be great, the losses can be just as big. For every point that the market moves against you, you will make a loss. Margin trading can cause you to lose more than your initial investment.
• CFD commodity trading, and indeed any CFD trading, is banned in certain financial jurisdictions, such as the US.

Strategies

CFD commodity trading is a different playing field from investing in company stocks. Given that CFDs are used for the most part as short-term investments, you will likely want to employ short-term intraday trading strategies when trading gold, coffee or other commodities.

You should also check the hours that the particular markets are open for trade. For coffee, the CFD commodity trading hours may be different from those of UK oil. As a general rule of thumb, CFD commodity trading can be conducted provided that the physical commodity market is open for trading.

Checking The News

You must look at the current price trends and latest news releases before beginning CFD commodity trading. Given that commodities are greatly influenced by supply and demand, you should take a bit of time to make yourself familiar with the particular instrument that you are interested in.

Is there a shortage of the particular commodity? Is there a surplus due to an exceptional harvest? Are there any laws or regulations being implemented that may impact the commodity? These are the sorts of questions you should be asking.

For example, when the news reported that a surplus of crude oil was beginning to form due to the drastic fall in demand for fuel during the initial lockdowns of the pandemic, it would have made sense to “short” the oil market as the price is expected to fall.

Hedging

As CFD commodity trading allows you to “short” a market, so you can trade any drop in value, you can utilise this as a means of counterbalancing your investment portfolio.

If you predict a sell-off of a commodity that you have already invested in, you can obtain short CFDs at a fraction of the price (using the margin decided by your broker) for the same amount of the commodity you possess.

This means any losses would be offset by the returns you make on the short CFD trade.

Check that your broker permits hedging first.

Scalping

This is one of the more popular strategies for CFD commodity trading. The aim of scalping is to exit positions quickly, with the aim of making small gains, reducing the risk of losing money from market reversals.

Again, check your broker permits scalping prior to trading.

As individual gains are often low, high margin levels are often used and a large number of trades are made throughout the day.

How To Start CFD Commodity Trading

Choose A Broker

To begin CFD commodity trading, you will need to choose a broker. Some of the key factors to consider are:

• Margin: If you plan to make use of leverage in your CFD commodity strategy, you should check whether a broker offers high leverage rates and low margin rates.
• Spreads: CFD brokers usually make their money through bid-ask spreads. The advertised buy price for a commodity will be higher than the actual market value and the sell price will be lower. The smaller than spread, the less the market needs to move for the trade to break even – or better.
• Costs & Fees: If holding a position overnight, brokers usually charge interest, which can increase with the number of days you maintain the position. These often vary between brokers, so if you intend to keep overnight holdings you should carefully consider these extra fees.
• Reputation: Is the broker well known? Have there been any reported issues with their platform before?

Popular CFD brokers such as Trading 212 and eToro allow you to trade most commodities — especially popular ones like gold — using CFDs.

Opening Your Position

Before opening any position on a commodity of your choice, you should only invest an amount that you are comfortable with losing.

On most broker platforms, opening up a CFD commodity trading position is simple and easy. You will be presented with an option to buy (go long) or sell (short) your chosen commodity. Going long on a commodity will mean that you will gain when the price of the commodity increases while shorting a commodity is the opposite.

The CFD trading view on the broker platform should offer you most of the information you require to place your position, such as any graphs and informatics on the chosen commodity market.

Monitoring Your Position

Given that the losses incurred when CFD commodity trading can be considerable and profit windows can be slim, you should keep tabs on any open positions.

If you believe that the commodity market in which you invested is beginning to move in the wrong direction, you should consider exiting to reduce or avoid losses. Some platforms allow you to place stop-limit boundaries, which help you define your acceptable loss limit before automatically exiting.

Tips For Trading

Here are a few helpful tips that you can take on board whilst CFD commodity trading:

• Don’t take on more than you can afford. Given that the per-point value difference is magnified by the size of your trade, you should set yourself a limit on what you consider an acceptable loss.
• Automate exiting your positions to help avoid losing more than you want and retaining trading capital.
• CFD commodity trading with margin could result in greater profits than otherwise, though losses will also be magnified in the same way.
• Be wary of any exchange rate fees. Some platforms may open your CFD trading positions in a different currency from your account’s base currency. Brokers will usually credit or charge your account after the exchange has been executed at the time of the transaction.
• CFD commodity trading can be used to hedge other investments, such as company stocks dependent on natural resources or currencies for economies that are heavily based on commodity exports.

Final Word On CFD Commodities Trading

CFD commodity trading greatly improves the accessibility of the commodities markets, allowing retail traders to viably trade price fluctuations of natural resources without the logistic issues presented by physically purchasing the goods. CFDs also allow for margin trading, automated trading and the shorting of commodities from gold to crude oil to coffee beans. To get started with CFD commodity trading today, see our list of the top brokers here.

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