Commodity Trading: A Comprehensive Guide to Profitability

Commodity trading involves buying and selling commodities — basic goods and raw materials such as oil, gold, wheat, or sugar — on regulated commodity exchanges. Traders can profit from commodity trading by speculating on price changes, often using futures contracts. These contracts obligate the buyer to purchase a specific commodity, and the seller to sell it, at a predetermined price and future date.

Types of Commodity Trading Analysis

Fundamental Analysis

Fundamental analysis involves evaluating a commodity based on real-world events and economic indicators. This includes factors such as weather patterns, geopolitical tensions, supply and demand dynamics, and economic data. For instance, a drought could decrease the supply of wheat, leading to an increase in its price. Traders using fundamental analysis would take such information into account when making decisions.

Technical Analysis

Technical analysis, on the other hand, relies on statistical trends gathered from historical commodity price and volume data. Traders use charts and various technical indicators to identify patterns that can suggest future activity. For example, a trader might use moving averages to identify a potential bullish (upward) or bearish (downward) trend in the price of gold.

Trading Strategies

• Day Trading

Day trading involves buying and selling commodities within the same trading day. The goal is to profit from short-term price fluctuations. Day traders typically use technical analysis and charting software to guide their decisions.

• Swing Trading

Swing traders hold onto their commodities for days or weeks, aiming to profit from price swings during this period. They use a mix of fundamental and technical analysis to guide their trading decisions.

• Position Trading

Position traders hold onto their commodities for months or even years. They typically rely on fundamental analysis, looking at long-term economic and industry trends to guide their trading decisions.

Developing a Trading Plan

Before starting to trade commodities online, it’s essential to develop a well-researched trading plan. It’s a comprehensive decision-making tool for trading activity. It helps to decide what, when, and how much to trade. A trading plan includes a trader’s personal financial goals, risk tolerance, methodology, and evaluation criteria. Once you have a plan, your trading becomes less subjective, you remove most of the emotion from your decisions, and thus, reduce the potential for making impulsive decisions.

A Real-World Examples

Futures

Let’s consider a practical example to illustrate how commodity trading works. Suppose a trader decides to trade Brent Oil futures. They might start by learning how to read and understand the crude oil inventories report published weekly (every Wednesday or Thursday) by the U.S. Government’s Energy Information Administration. This report provides valuable data and analysis on the supply and demand dynamics of the oil market, which can significantly impact oil prices. For instance, if reserves are diminishing, this could signal a rise in prices, and conversely, if oil stocks are increasing, this could be a signal for a decrease.

Suppose the trader predicts that oil prices will rise based on their analysis of the report. They might decide to buy a futures contract for 1,000 barrels of oil at a price of $60 per barrel, with the contract set to expire in one month. If the price of oil rises to $65 per barrel by the contract’s expiration date, the trader could potentially make a profit of $5,000 (1,000 barrels x ($65 – $60)).

However, if the price of oil falls to $55 per barrel, the trader would face a loss of $5,000. This example illustrates the potential for both significant profits and substantial losses in commodity trading.

Futures and Margin Calls

Trading in futures requires a good-faith deposit or margin. Commodities are a volatile market, and margin calls requiring additional capital are likely. A margin call occurs when a broker requires a trader to put more capital into their account because the value of their investments has fallen below the minimum required equity balance. Trading on margin can be risky and costly, and many traders lose a significant amount of money this way.

FOREX Market 

In the context of Brent Oil on FOREX, a CFD is a contract that allows traders to invest in price movements of Brent Crude Oil without actually owning the underlying asset. 

A Contract for Difference (CFD) is a popular form of derivative trading. CFD trading enables to speculate on the rising or falling prices of fast-moving global financial markets, such as forex, indices, commodities, shares, and treasuries.

*4h Brent Oil graph 

Technical Analysis

On the 4-hour chart, we can see that oil is trading in a downward price channel, but it has entered a correction phase for the past three weeks. The price has repeatedly bounced off the ascending trend line. The important support levels at 75.43 and 77.29, while resistance levels at 80.22 and 82.97.  

The Moving Average (200) is above the price, which may indicate downward pressure, however, the RSI is above 50, which suggests an upward movement.

Fundamental Analysis

As of May 24, 2023 the U.S. Government’s Energy Information Administration (EIA) report showed a significant reduction of U.S. Crude Oil Inventories by 12.456M barrels while Gasoline Inventories by 2.053M, which is very supportive for the Brent Oil prices.

At the same time the U.S. Government  signed off on an agreement to temporarily suspend the debt ceiling and cap some federal spending in order to prevent a U.S. debt default. 

Assuming all the positive facts we may propose the further price rise of Brent Oil up to 80.22 and 82.97 levels. 

This is just a simple example of combined analysis for the trading instrument. There are many other technical indicators and strategies that traders can use for profitable deals. 

Summary

Commodity trading can be a profitable venture, but it’s not without risks. It requires a deep understanding of the markets, a solid trading strategy, and the ability to analyze various economic and market indicators. Whether you’re a day trader making multiple trades a day or a position trader holding onto your commodities for months, successful commodity trading requires patience, discipline, and a keen understanding of the global economy.