How to Trade Commodities？

Commodity trading has been a part of economic and social activities since ancient times, and it was initially manifested as barter exchange. With the development of society, commodity futures trading gradually formed.

What are Commodities？

Commodity futures trading in the true sense originated in the United States in the mid-19th century, when farmers and merchants began to use forward contracts to protect against the risk of future price fluctuations, agreeing to buy and sell grain or other commodities at a specific time in the future at a predetermined price. The birth of the modern futures market was marked by the founding of the Chicago Board of Trade (CBOT) in 1848, which pioneered standardized futures contracts, making commodity futures trading more standardized and easier to circulate.

Over time, the commodity futures market has expanded from agricultural products to metals, energy, chemical products and many other fields. In the second half of the 20th century, financial futures and other derivatives appeared one after another, further enriching and improving the global futures trading system.

Characteristics of Commodity Markets

• Commodity diversity: The commodity market encompasses a wide range of commodity categories, covering a variety of physical commodities such as agricultural products, industrial products, mineral resources, and energy products.

• Standardized contracts: In the commodity market, many commodities such as gold, crude oil, grain, etc., have formed standardized contract specifications and quality standards, which is convenient for both sides of the transaction to refer to the implementation.

• Price discovery mechanism: commodity market establishes fair price through centralized bidding, reflecting market supply and demand relationship and pricing of future expectations.

• Diversified trading forms: commodity trading has both immediate delivery of spot trading, and futures trading agreed on the future delivery price and time, and the futures market provides a channel for participants to avoid price risks.

• Cyclical and volatile characteristics: Commodity prices are driven by the fundamentals of supply and demand, usually showing certain seasonal and cyclical changes, and there are short-term and long-term price fluctuations.

• Macroeconomic linkages: Commodity markets are deeply affected by global economic conditions, and monetary policies, exchange rate changes, policy adjustments and changes in the international trade environment will significantly affect commodity prices.

• Risk attributes: Due to the fragility of the commodity itself, easy storage and other characteristics, as well as the speculative activities in the market, the commodity market usually contains a high risk.

• Characteristics of globalization: The modern commodity market has distinct characteristics of globalization, and commodity prices are easily affected by events on a global scale, forming a linkage reaction.

• Fierce market competition: a large number of buyers and sellers compete in the commodity market, prompting the formation of commodity prices and improving market efficiency.

• The derivatives market is closely linked: many commodities have supporting futures, options and other derivatives markets, and the physical commodity market and the derivatives market are intertwined, jointly building a complete commodity market system.

Main Commodity Category

• Agricultural products:

Food crops: wheat, corn, rice, soybeans, etc

Oil crops: palm oil, soybean oil, rapeseed oil, etc

Sugar: raw sugar, white sugar, etc

Soft commodities: cotton, coffee, cocoa, sugar, etc

Meat products: pigs, cattle, sheep, poultry, etc

Fruits and vegetables and nuts: apples, oranges, bananas, walnuts, almonds, etc

Feed and seed

• Energy Category:

Crude oil and refined oil products: WTI crude oil, Brent crude oil, gasoline, diesel, aviation kerosene, etc

Natural gas

coal

Nuclear energy, hydropower, wind energy and other new energy related futures or derivatives

• Metals:

Precious metals: Gold, silver, platinum, palladium, etc

Industrial metals: copper, aluminum, lead, zinc, nickel, tin, etc

Steel and its products

Other rare metals: tungsten, molybdenum, lithium, cobalt, etc

• Chemicals:

Basic chemicals: ethylene, propylene, benzene, methanol, etc

Agricultural chemicals: fertilizers, pesticides, etc

Synthetic rubber

Plastics and resins

rubber

Trees and pulp

• Other Product categories:

Live animals (e.g., wool, fur)

Currency (Foreign Exchange)

Financial derivatives (such as stock index futures, Treasury bond futures, etc.)

Environmental protection products (Carbon emission rights)

The difference and connection between futures and commodities

Difference

• Definition:

Commodities refer to physical products that are traded in economic activities, such as crude oil, gold, corn, copper, etc. They have practical value and can meet people's life or production needs.

A Futures is a type of financial derivative that represents a standardized contract for the right and obligation to buy or sell a commodity or other asset (including non-physical commodities such as stock indexes and interest rates) at a predetermined price on a specific date in the future.

• Trading methods:

Commodity trading is usually directly related to the buying and selling of physical commodities and can be carried out through spot markets or forward contracts.

Futures trading is carried out within a futures exchange, where buyers and sellers do not involve immediate delivery of physical commodities, but speculate or hedge against future expected price changes through a margin system.

• Purposes and uses:

Commodity trading mainly serves the needs of the real economy, including production, consumption, storage and investment value-added.

The purpose of futures trading is not only to provide risk management tools for real enterprises (i.e. hedging), but also to provide investors with the function of price discovery and risk transfer, and to allow speculators to take advantage of price fluctuations to obtain profits.

Connection

• Relevance of the target:

The subject matter of many futures contracts is a commodity, such as soybean futures, crude oil futures, etc., which means that the price trend of the commodity directly affects the value of the relevant futures contracts.

• Risk Management:

Commodity producers and consumers can use futures markets to manage price risk and lock in future costs or revenues. For example, a farmer of an agricultural product may sell a futures contract as a pre-sale of his product to avoid the risk of future market price declines.

• Market linkage:

Price movements in commodity markets and futures markets usually affect each other. The price change of the futures market will reflect the market's expectation of the future commodity price, and the supply and demand situation of the commodity spot market will affect the pricing of the futures market.

Application of Futures Contracts

Futures contracts are widely used in hedging, risk management, speculative trading and other aspects, by locking future prices, transferring risks and providing market expected price signals, to achieve effective connection between the real economy and the financial market and optimize resource allocation.

• Hedging: Futures contracts help producers, traders, and users lock in future prices and avoid the risk of price fluctuations in raw materials or products. For example, farmers can lock in the sale price in advance by selling futures contracts in case the market price falls at harvest time. Similarly, manufacturers can lock in production costs by purchasing futures contracts for raw materials to protect against rising raw material prices.

• Risk management: Companies use futures markets to hedge risks in existing portfolios, especially foreign exchange and interest rate risks. For example, multinational companies can use foreign exchange futures contracts to hedge exchange rate risk and maintain stable cash flows.

• Speculative trading: Investors can speculate on the market price trend through the futures market, whether the price rises or falls, they can buy or sell futures contracts to obtain profits. Futures markets provide leverage, allowing investors to trade larger amounts with relatively small initial margins.

• Asset allocation: In portfolio management, futures contracts can be used to diversify investments, and by allocating different types of futures products, investors can gain relevant market exposure without directly owning physical assets.

• Price discovery: The open and continuous bidding trading mechanism in the futures market promotes the effective formation of market prices, and provides a reference basis for future price expectations in the spot market.

• Liquidity management: For financial institutions, futures contracts are a tool to manage liquidity and optimize the structure of assets and liabilities, especially when the cost of funds and interest rates are unstable.

• Index futures Linked to ETFs: Index futures contracts are often used to hedge risk in stock portfolios or as a quick tool for institutional investors to adjust large stock portfolios. At the same time, some exchange traded funds use futures contracts to track the performance of the underlying index.

• Physical delivery and cash settlement: Although most futures contracts are closed before expiration, some contracts actually fulfill their physical delivery obligations on the physical delivery date, which plays a role in regulating the supply and demand balance in the physical commodity market.

How Do I Open an Account？

• Choose a futures company: First of all, you need to choose a legitimate and reputable futures company, ensure that it has a record with the China Securities Regulatory Commission (CSRC) and obtain futures brokerage qualifications.

• Prepare documents: Prepare the original personal ID card, bank debit card (debit card), and the recently issued address proof (such as the real estate certificate, lease contract, or the recent three months of utility bills) and other documents.

• Sign the agreement: Go to the selected futures company's sales department or fill in the account opening application form through the online account opening channel, read and sign the futures trading risk disclosure letter, customer notice and other relevant documents.

• Identity verification: Submit personal information, perform video witness or on-site witness, complete identity verification and image collection.

• Bind your bank card: Follow the prompts to bind your bank account for easy access.

• Open trading rights: After passing the audit, the futures company will open the trading code and rights for you, at this time you can download the futures company's trading software and log in to trade.

• Deposit trading: According to your own needs, you can start futures trading after transferring funds to the futures account.



Market Supply and Demand Analysis

• Commodity market supply analysis

Supply analysis: The analysis of the total amount of goods that commodity producers are willing and able to provide in a given period of time. This depends on a variety of factors, such as production costs, technological development, capacity utilization, raw material supply, policies and regulations, and producers' expected prices.

Elasticity of supply analysis: Measures the relationship between the percentage change in price and the percentage change in supply to assess the steepness of the supply curve. The elasticity of supply determines the extent to which price changes affect the quantity supplied.

• Commodity market demand analysis

Demand analysis: The analysis of the total amount of goods in the market that consumers are willing and able to buy at a given price level. Influencing factors include consumer income, demographics, consumption habits, price changes in substitutes and complements, and consumer expectations about future prices and economic conditions.

Elasticity of demand analysis: The sensitivity of the demand curve is assessed by calculating the proportional relationship between price changes and changes in demand. The elasticity of demand affects the intensity of the influence of price changes on the quantity demanded.

Through in-depth analysis of the market supply and demand relationship, enterprises and investors can accurately predict the future trend of commodity prices, which is crucial to guide production and investment decisions.

For example, when the oversupply or demand of a certain commodity is expected, the enterprise can adjust the production plan and inventory management strategy according to the forecast, timely increase and decrease the inventory, and prevent the cost loss caused by the inventory overhang or supply shortage caused by the imbalance of supply and demand.

At the same time, with the help of financial instruments such as hedging and insurance, enterprises can effectively cope with the sharp fluctuations in commodity market prices, reduce the potential financial risks brought by this, and ensure the stable operation of enterprises.

How to Invest in good commodities？

For those seeking to profit from market volatility, investing in futures can be a high-risk, high-reward strategy. Here are good strategies for investing:

• Understand the market and product characteristics:

Study the supply and demand fundamentals of different commodities, including production, consumption, inventory, seasonal factors, and global economic conditions.

Understand the risk attributes and cyclical characteristics of commodities, such as energy commodities are often affected by international political situations, and precious metals have hedging functions.

• Choose the right investment vehicle:

Direct purchase of physical goods: such as buying physical gold, silver, etc., as a long-term hedge asset.

Invest in commodity futures or options: Profit from price fluctuations through margin trading on futures exchanges, but be aware of leverage risks.

Buy commodity-linked exchange-traded funds (ETFs) or index funds: These products track the price movement of specific commodities and are suitable for investors who don't want to participate directly in the futures market.

Invest in mining stocks or related companies: Indirectly invest in commodity markets and share in the growth of corporate earnings brought about by rising commodity prices.

• Develop an investment strategy:

Combination of long term and short term: According to the market trend, you can make medium - and long-term value investment, but also use short-term fluctuations to do short-term trading.

Diversification: Spread your money across a number of different commodities to reduce the risk of price fluctuations in a single commodity.

Set a stop loss and profit point: set a reasonable stop loss level when trading to control possible losses, and set a target profit point to lock in profits in time.

• Monitor macroeconomic and policy developments:

Macroeconomic data, monetary policy adjustments, geopolitical events, etc., can have a significant impact on commodity prices, and this information is closely monitored in order to make timely decisions.



How to Manage Risk？

• Hedging: The use of financial derivatives such as futures and options to lock the future price of commodities to offset the impact of spot market price fluctuations on corporate profits. For example, in the commodity futures market to establish the opposite position to the spot market, to achieve hedging risk.

• Portfolio Diversification: diversification of investment in different commodity types, regions or industries in order to reduce the impact of price fluctuations of a single commodity or market on the overall investment effect.

• Supply Chain Management: strengthen cooperation with suppliers to ensure the stability and resilience of the supply chain, and maintain sufficient safety inventory to cope with the risk of sudden supply disruptions; At the same time, through market research and data analysis, forecast and adapt to changes in market demand.

• Long-term Contracts: The signing of long-term supply or purchase contracts with suppliers or customers, stipulating fixed prices or price formulas, thereby locking in costs or sales revenue to a certain extent.

• Commodity Insurance: For risks such as natural disasters, theft and damage that may be encountered during transportation, enterprises can choose to purchase appropriate insurance products to transfer risks.

• Policy Monitoring: Tracking changes in domestic and international policies and regulations, and responding promptly to policy adjustments that may affect commodity prices and supply.

• Establish a Risk Management Department: Establish a dedicated risk management department responsible for monitoring market risk, assessing risk exposure, and designing and implementing risk management strategies.

• Use Big Data & AI Technologies: Use modern information technology to analyze massive data, improve the prediction accuracy of market trends, and help risk warning and management decisions.

How to Trade Commodities？

Commodity trading strategy is a systematic rule designed by investors based on technical analysis, fundamental analysis and market behavior characteristics in the commodity market, which is used to decide when to buy, when to sell and how to manage risks, so as to capture the profit opportunities brought by price fluctuations. The following are common trading strategies:

• Trends follow:

The trend following strategy is to enter the trade when the price of a commodity forms a definite upward or downward trend, taking advantage of the momentum to continue to drive the market price.

Technical analysis tools such as moving averages, MACD, Bollinger bands, etc. can help identify and track trends.

• Arbitrage trading:

Take advantage of the price differences between different markets or different month contracts to carry out risk-free or low-risk trading, such as inter-span arbitrage (the price difference between futures contracts of the same commodity but different delivery months), cross-market arbitrage (the price difference of the same commodity on different exchanges), etc.

• Mean reversion:

When the price of a commodity deviates far from its long-term average, it is considered to have a tendency to return to the mean, and the strategy of long oversold commodities or short oversold commodities can be used.

• Seasonal Deals:

According to the historical seasonal performance of commodities trading, some commodities due to their production cycle, consumption habits and other reasons have a certain seasonal price fluctuations.

• Macroeconomic drivers:

Analyze fundamental factors such as global economic conditions, policy changes, supply and demand, and predict commodity price trends and establish positions accordingly.

• Relative value strategy:

Similar to the long-short pairing trading proposed by Huachuang Securities, such as more than one commodity while shorting another related commodity, the price relationship between the two is expected to reverse.

• Quantitative Trading Strategies:

Identify trading opportunities through mathematical models and algorithms to automate the execution of buying and selling decisions, which can include complex strategies such as statistical arbitrage and machine learning forecasting.



Common Trading Platform

• CME Group: The Chicago Mercantile Exchange (CME), which provides futures contracts for a variety of commodities, including agriculture, energy, and metals.

• ICE: Involved in energy, agricultural products, financial derivatives and a wide range of commodity futures and options trading.

• Shanghai Futures Exchange (SHFE) : One of the major futures exchanges in China, trading non-ferrous metals, ferrous metals, precious metals, energy, chemicals, agricultural commodities and other commodities.

• Dalian Commodity Exchange (DCE) : mainly deals in grain, oil, oil, wood, animal husbandry, energy and chemical futures.

• Zhengzhou Commodity Exchange (CZCE) : one of the earliest established commodity futures exchanges in China, trading varieties including agricultural and non-agricultural products futures.

• EUREX: offers a range of commodity futures and options products.

• Cryptocurrency exchanges such as Binance Futures, OKEx and Huobi also offer some commodity-related derivatives trading services, such as digital currency contracts linked to gold and silver.



Conclusion

As an important investment method, commodity trading covers the trading activities of physical commodities (such as crude oil, gold, agricultural products, etc.) and their derivatives on major commodity exchanges and various online trading platforms around the world. With the help of the judgment of the future trend of commodity prices, investors realize capital appreciation by buying low and selling high.

In actual commodity trading, traders should not only comprehensively study commodity fundamentals and technical information, but also develop targeted trading strategies, clarify risk management plans and timely adjust strategies, effectively control positions and diversify investments. Only by keeping up with market changes and constantly improving trading skills and strategies can we get the maximum benefit.

FAQs

Q：What are the main factors on which commodity food prices move？

A：Supply and demand, weather, natural conditions, government policies, international situations, energy prices, and production costs all play a role

Q：How do I buy crude oil？

A：The main ways to buy crude oil include physical purchases, trading in futures contracts, investing in related ETFs or ETN products, options trading, and indirect participation through mutual funds or commodity funds.

Q：Is there much room for gold and silver commodities to appreciate？

A：There is some room for appreciation. The investment value of gold and silver commodities is also affected by factors such as their purity, weight, and production process. Generally speaking, the higher the purity, the greater the weight, and the more exquisite the production process of gold and silver commodities, the higher the investment value.

Q：How to day trade stocks？

A：When day trading in the stock market, investors need to have a deep understanding of market dynamics and be prepared to pay close attention to stock price movements throughout the day, execute buying and selling operations in short-term price fluctuations, and strictly follow risk management strategies.

Q：What is future brokerage？

A：This is a financial service provided by a professional financial intermediary (i.e. a futures broker or futures company) to help individual and institutional clients to buy and sell futures contracts on a futures exchange. A futures is a standardized contract to buy or sell a commodity, financial instrument or index at a predetermined price at a specified time in the future.