What is Commodity Trading?

Commodity trading is an investing strategy that involves the buying and selling of goods that are classified as commodities. There are many similarities between commodity trading and the trading activity involved with stocks. One key difference has to do with the difference between what is traded.

A commodity is normally defined as something that is considered to be of value, has a quality that is more or less consistent, and is produced in large amounts by a number of different producers. When people choose to invest in commodities, they normally think in terms of items that are resources that may be purchased for a wide range of uses. For example, corn is considered a commodity and is traded on the basis of the wide range of goods that can be produced using corn as a base ingredient.

In order to trade commodities, it is necessary to participate in transactions conducted on a commodity exchange. Functioning in a manner very similar to a stock exchange, there are exchanges that deal directly with commodities all over the world. However, it is not necessary to limit the commodity trading to one particular exchange. Investors are free to buy and sell on several exchanges if they so desire and are recognized by the exchange.

The process of commodity trading is directly affected by the current relationship between supply and demand for a given commodity. Any factor that limits the supply may cause the value of the remaining quantities of the commodity to gain in value very quickly. For example, if a natural disaster wiped out a significant portion of wheat, the worth of remaining wheat resources would be in greater demand. As a result, the price for the commodity would rise and any investor with investments in the wheat market would stand a good chance of earning a substantial return.

At the same time, a glut of a commodity that exceeds the current level of demand may drive the unit price down. This could result in a loss to the investor, assuming the price falls below what was originally paid for the investment. Often, the commodities investor will have to decide whether to absorb the loss or prevent additional losses by selling at the current lower unit price. If there appears to be no hope for the commodity to recover within a reasonable amount of time, the investor is likely to sell. However, if there are indicators that the commodity will recover and demand will rise within a short period of time, there is a good chance that the investment will remain in place in hopes of recouping all losses at a later date.

As with stock trading, commodity trading involves some degree of risk. Investors do monitor the relationship between supply and demand and how that factor impacts the information currently available through a commodities price index. While commodities are usually considered more consistent and stable than some other forms of investing, there is always the chance that natural disasters, changes in consumer tastes, or political issues may negatively impact the worth of any commodity.