Basics of Commodities and Commodity Trading
What are commodities
A commodity is a basic good used in commerce. That is interchangeable with other commodities of the same type. Commonly traded commodities include gold, beef oil, lumber and natural gas. Additional examples of commodities include iron, ore, crude oil, salt, sugar, tea, coffee beans, copper, rice, wheat, silver, and platinum. Commodities are basic. Because they have simply been grown or extracted from their natural state and brought up to a minimum grade for sale in a marketplace. There is no extra value added to them by the producer. Although the quality may differ slightly between producers. Commodities by definition are very similar. No matter who produces them. All commodities of the same grade are priced equally and are interchangeable. The most widely traded commodities have well-established markets. Investors buy and sell commodities through futures contracts on exchanges. The exchanges standardize the quantity and minimum quality of the commodity. for example, the Chicago Board of Trade stipulates that one wheat contract is comprised of five thousand bushels. It also states what grades of wheat can be used to satisfy the contract. All weeds that meet that grade, no matter where it was grown. Despite slight variations in quality will be sold for the same price.
How commodities are traded
Raw commodities are bought sold or traded in a commodity market. Hard commodities are natural resources that are mined or extracted. Such as gold and oil. All commodities are agricultural products such as wheat or livestock. There are currently 50 physical and virtual commodity markets worldwide. Where almost 100 primary commodities trade through the exchange of ownership rights. The actual commodities don't change hands. A commodity market can create a large economic impact by influencing the prices companies pay for certain raw materials. An uninformed investor who trades in a commodity market is essentially gambling or speculating but buying into a commodity. Futures contract enables investors and companies to lock in quantity price and delivery date, therefore, minimizing volatility and helping them to plan business endeavors. Futures contracts provide the most direct way to invest in a commodity market. Investors also buy stocks from corporations whose businesses rely on commodity prices. Or they buy mutual funds ETF and index funds that focus on commodities-related companies.
Why Trade in Commodities
Commodity trading can be done for various purposes out of which two are most important:
- Against the exposure towards physical trades -for risk management (Hedging)
2.Having no exposure in physical form ( Investment & Speculation)
Hedging is the practice of offsetting the price risk inherent in any cash market position by taking an opposite position in the futures market. A long hedge involves buying futures contracts to protect against the possible increasing prices of commodities. A short hedge involves selling futures contracts to protect against possible declining prices of commodities.
Speculation is the practice of engaging in risky financial transactions in an attempt to profit from short or medium term fluctuations in the market value of a tradable good such as a financial instrument ex-commodity.
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