COMMODITIES

What is the raw material? To fully understand commodity trading, this question must be adequately answered. The raw material (or commodity) is a material deriving from natural resources and considered in the raw state which, after certain manufacturing processes, is used for the production of goods. Gold and oil are two commodities – well-identified in the collective imagination – that can help to better understand the meaning of commodities. These two raw materials are extracted from natural resources and then sold to specialized companies, which work them to create luxury or technological goods (gold) or refined products such as plastic, diesel, asphalt, tar and etc. (oil). A characteristic of raw materials is that of being an undifferentiated good. This means that their production is standard in terms of quantity and quality and the relative price is always the same, regardless of the manufacturer. The main stock exchanges in the world where commodities are traded are the NYMEX, Ney York Mercantile Exchange, the CME, Chicago Mercantile Exchange, and the LME, London Metal Exchange.

Commodity trading, or commodity trading, consists of trading these resources on the financial markets, in an attempt to make a profit based on price fluctuations. In detail, traders who decide to trade on raw materials hypothesize a change in the price of the commodity itself, which can be up or down. Commodity trading is often considered a speculative action, therefore suitable for investors who prefer short-term trading, but the fact remains that there are investors who choose the commodities market for medium-long term investments. As we will see in the next chapter there are several derivative instruments that allow trading on commodities, specifically CFDs, futures, spots, and ETCs

The main trading of commodities takes place through derivative instruments, such as Futures, CFDs (Contracts for difference), and ETCs (Exchange Traded Commodities). Let’s analyze every single tool in detail.

Futures and spots on commodities

Futures, are financial instruments used to invest in commodities. In detail, they allow traders to invest through a commitment to buy (or sell) a certain quantity of the chosen raw material in the future, at a previously set price. Ultimately, a commodity future is in effect an investment that aims to predict the value of the commodity in the future. Futures, differ from Spot purchases of raw materials, in which the purchase allows for the immediate transfer of the commodity between buyer and seller.

CFDs and commodity trading

CFDs or Contracts for Difference, are undoubtedly one of the most popular instruments for those who trade on commodities. This is because its nature allows you to invest quickly in the financial markets. A CFD aims to faithfully replicate the performance of another financial instrument. In our case, a commodity CFD replicates the performance of a commodity futures verbatim. Simplifying: if a trader chooses to invest in an oil CFD they choose a product that will replicate the performance of an oil future. Among the main features of CFDs that attract commodity investors is undoubtedly the concept of financial leverage, a mechanism that can allow traders to use reduced capital and increase their exposure. It goes without saying that this choice can lead to multiplied gains as well as multiplied losses.

ETCs and commodity trading

ETCs (Exchange Traded Commodities) are a unique tool for investing in commodities. In detail, they represent securities with no maturity issued by an SVP, or a vehicle company that invests directly in certain commodities. The objective of ETCs is the passive replication of the performance of one raw material or a set of raw materials. Unlike ETFs, where diversification of basket securities is envisaged, it is also possible to invest in a single commodity in the ETC. The success of an ETC investment is closely linked to the performance of its underlying, which can be represented by a single commodity or a set of commodities, depending on the choice of the issuing SVO.

Spread trading on commodities is an investment strategy that was formed in America and which is rapidly gaining ground also in Europe. The Spread trading strategy is based on the concept of “spread”. In detail, those who adopt this operating method acquire two opposite positions (one short and one long) in two related assets and try to earn on the spread. Usually, the most popular technique (pair trading) is to choose, within the same sector, a stock that is believed to be strong for a long (long term) investment and a stock that is believed to be weak for a short (short investment term). This strategy is called a “divergent approach”. Similarly, a different approach can also be activated, defined as convergent, where the estimate deriving from the technical analysis identifies an overvalued and undervalued security. In this case, we look for a realignment of the securities, through a strategy defined as “fair value”.