There are many different ways to trade in the markets today. Contract for difference (CFDs) is one way to profit from the price movement of commodities.
What are Commodities
Traders trade commodities on commodity exchanges and brokerage firms. Commodity CFDs that can be traded include:
- Energy: Natural gas, West Texas Intermediate crude oil, Brent crude oil, and heating
- Agriculture: Coffee, oats, soybeans, cotton, sugar, lumber, cocoa, wheat, and orange juice
- Precious metals: Gold, silver, platinum, and palladium
- Livestock: Cattle, feeder cattle, hogs, and pork bellies
- Industrial metals: Aluminum, tin, lead, zinc, molybdenum, recycled steel, and nickel
Who Trades Commodities?
Individuals and large businesses buy and sell commodities every day. Some trade them for only profit, while others trade them for business purposes.
For example, a breakfast food company needs to buy wheat for its cereal. They will enter into a commodity contract for wheat that is to be delivered at a future date. Buying the wheat before they need it locks in the price.
On the other side, farmers will use the commodity markets to sell their wheat which they will deliver to the breakfast food company for the agreed price on the future date.
Basics of Commodity CFD Trading
A CFD is a contract between you and another party. Before entering into a CFD, you must first decide which commodity you want to trade and the direction of the price. Many traders will use technical analysis, which uses charts to track current and future price directions.
If you believe the price of gold was going higher by a future date, you would buy a gold CFD. This is also known as going long.
If you paid $500 for a gold CFD and a month later the price of gold moved up, you would close out your CFD, and the profit would be the difference between what you paid and what you sold it for. If you sold the contract at $575, you would profit $75 minus the commission cost.
If, after analysis, you believed that the price of gold was going to drop, you could sell a gold CFD, known as going short. In the same example, you would sell (go short) a gold CDF for $500. If the price of gold did drop to $425 when you closed out your position, you would profit by $75.
Reducing the Risks of CFD Trading
In the above examples, if the price of gold had moved in the other direction than you expected, you would have had to sell for a loss.
Learning how to trade CFD contracts also means learning about the risks and how to reduce the risks. According to Capital.com, “A hedge is a risk management technique used to reduce losses. You hedge to protect your profit, especially in times of uncertainty. The idea is that if one investment goes against you, your hedge position goes in your favor.”
Trading commodities CFDs is a good way to profit in the commodities market, whether prices are rising or falling. When you first learn how to trade CFD contracts, it is best to practice with a demo account before risking actual money.