Commodities Trading Basics: How Does Commodities Market Work?
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How Does The Commodities Market Work?

What Is a Commodity Market?

Similar to any other market around the world, the commodity market allows participants to buy or sell products that range from luxuries to everyday essentials. Many commodity centers exist around the world, facilitating trade between suppliers, manufacturers, speculators, and others.

 

Commodities are usually separated into two groups: Soft and hard commodities.

 

Soft commodities are mostly agricultural and are grown and harvested. They include popular and mainstream ones such as corn, wheat, sugar, soybeans. Another type of soft commodity includes livestock like pork and hogs. On the other hand, hard commodities are natural resources that are extracted from the earth and include gold, oil, natural gas, and copper. 

 

Commodities can be broken down further into multiple categories in the following manner: (Figure 1)

 

Metals: Gold, Silver, Platinum, and others.

Energy: Crude Oil, Heating Oil, Natural Gas among others.

Agriculture: Cocoa, Coffee, Cotton, Sugar, and others.

Livestock and Meat: Hogs, Pork Bellies, and others.

Figure 1 - 2-Hour Chart of Gold, Crude Oil and Coffee

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How Commodity Markets Work

The commodity market allows a wide range of market participants to gain access to a centralized and liquid location that includes around 100 major products. Participants include outright suppliers and producers, focusing on obtaining or simply selling the commodity while others may be looking at it as a way to hedge against a certain exposure in the same product or another. Speculators and investors are also present in the commodities market, betting on a rise or fall in prices while others may hold commodities to protect their portfolio against adverse market conditions.

 

Certain commodities may act as a hedge against certain uncertainties such as inflationary expectations while a group or basket of commodities can also be useful in times of volatility given their tendency to move opposite of stocks.

 

Commodities prices are affected by a variety of factors that are fairly common across all other markets including supply & demand, Geopolitical tension, Central bank and interest rate decisions, Economic conditions, and many more. Specifically, for commodities, the supply & demand element is strong as many of the traded commodities are seasonal or affected by factors that could lead to disruptions of supply or demand.

Brief History of Commodity Markets

Historically, commodities date back thousands of years when tribes and older civilizations traded different products against each other including commodities, food, and other items. Technically speaking, it was the only way to pay for essentials and this practice continued into more recent history until currencies became a means to transact.

 

Trading in commodities was not available to everyone and required large sums of money, time, and the necessary expertise to be a market participant. With the advent of technology, trading commodities is something available for access to nearly all traders and investors and with plenty of ease.

 

One of the oldest and most popular exchanges is the Chicago Board of Trade. The CBOT started in 1848 and allowed for trading on agricultural commodities such as wheat and corn. This helped farmers and consumers manage risk by eliminating uncertainty in prices from the traded products. Today, the CBOT is one of the biggest in the world, offering options and futures on a wide range of products including commodities, interest rates, and equity indices.

Types of Commodity Markets

Commodities are available for trading in the spot markets or