How Do the Commodity Markets Work?

Explaining all the intricacies of commodities trading can be somewhat complicated, and you’d probably need an entire book to give you a clear idea of what it’s all about. But if you’re trading online and just want a basic idea of how it works, then that’s much simpler to do. Basically, it’s a bit like trading stocks, but instead you’re trading commodities. To make money, you just need to buy low and then sell high.

What’s a Commodity?

A commodity is just about anything that people mine, grow or produce and other people need. These commodities include:

  • Precious metals like gold, silver and platinum;
  • Energy products such as natural gas and crude oil;
  • Food products like orange juice and coffee;
  • Livestock such as cattle;
  • Industrial products like lumber or cotton;

What’s a Futures Contract?

This is a contract which protects hedgers (such as farmers who grow livestock or a mining company that produces gold) from adverse price changes or simply from being at the mercy of a dealer. The contract specifies the size and quality of the commodity (such as a thousand barrels of fine crude oil), the place where delivery can be made, and the price of the transaction.

It’s this contract that’s being bought and sold on the commodities market. As long as you buy and sell the contract before the delivery of the commodity is to be expected, then you’re only dealing with paper contracts.

Making Money from the Commodities Market

You can buy commodities like gold bars, and then sell them for a higher price. With commodities trading, it’s a bit different. To “own” a futures contract, you usually have to put up only a small fraction of the value of the contract. This money serves as a type of security bond, and you can lose part or all of it if the market goes against your position. You can even lose more than what you put up. But if you called the market correctly, then your profits are multiplied too.

Let’s say you’re trading online and you have $25,000 reserved for commodities trading. Now let’s assume that gold is currently pegged at $1250 an ounce and you think it’s bound to go higher. So you can buy 200 ounces of gold, or invest your money in a mining company that produces gold.

But you can also buy 2 futures contracts. A gold futures contract involves a hundred ounces of gold, and that means it’s worth 100 x $1250 or $125,000. So if you’re only required to put up 10% of the contract’s value then you can put up $12500 per contract.

Now what if the value of gold rises up by 10% in a month? If you’ve bought 200 ounces of gold, then its value would now be $27,500 because of the 10% increase. But because you bought futures contracts that’s worth 10 times the money you’ve put up, your two contracts worth a combined $250k becomes $275k. That’s a $25k profit—and you’ve effectively doubled your money on a 10% increase in price.

You now only have to pay a few dollars on commissions when you’re trading online. What remains is profit, and all because of commodities trading.

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Symbol Bid Ask Spread
EURUSD 1.22950 1.22970 2
GBPUSD 1.39690 1.39720 3
USDCAD 1.26430 1.26460 3
USDJPY 106.850 106.870 2
USDCHF 0.93590 0.93620 3
AUDUSD 0.78360 0.78390 3
NZDUSD 0.72910 0.72960 5
EURGBP 0.88000 0.88030 3
EURCHF 1.15090 1.15120 3
EURJPY 131.380 131.410 3
AUDJPY 83.730 83.780 5
GBPJPY 149.260 149.320 6
XAUUSD 1328.76 1329.16 40
XAGUSD 16.516 16.566 5