Liquidity is one of the most important factors for active commodity traders. The higher the volume of a futures contract on a commodity, the easier it is to buy and sell markets with narrow bid/offer spreads creating less slippage. Slippage is loss due to illiquidity and problems that arise during the execution of trades. Commodities with high volume are often the markets of choice for day traders and many large traders. Low-volume commodity markets are often prone to wild price swings.
Financial futures are designed as commodities as they are under the regulatory umbrella of the Commodity Futures Trading Commission (CFTC). The E-mini S&P 500 and Eurodollar markets are among the highest-volume futures markets, but for our purposes here, we will just concentrate on commodities for these rankings.
- Commodities that are traded at high volume are the most liquid, or the easiest to buy and sell, and have the least risk of loss due to slippage.
- Trade volume, open interest, and volatility, are among the most important factors to consider when evaluating commodities or futures.
- Macroeconomic forces, such as supply and demand, speculative buying, and developments in investment products, can all affect a commodity's liquidity.
Commodities Ranked by Volume
Below are the rankings of the most liquid commodities markets that trade in the U.S. —ranked from higher to lower volume. The commodities not listed are considered to have much lower average trading volume.
- Crude oil
- Natural gas
- Heating oil
- RBOB gasoline
- Soybean oil
What to Look for When Considering Liquidity
When it comes to selecting commodity markets to trade, there are a number of metrics that can assist us in terms of making the best choices. Liquidity is a significant consideration. It is important to be able to enter and exit positions without a great deal of slippage. Slippage is the loss that occurs due to wide bid-offer spreads or price gaps that can occur in commodities that exhibit low degrees of liquidity. Highly liquid commodities have less risk of slippage, not because they are more or less volatile, but simply because more people trade them.
When evaluating a commodity for tradability, important metrics to watch for are volume and open interest. Volume is the total number of contracts that trade, and open interest is the total number of open long and short positions in a market. The more volume and open interest in a commodity, the less slippage. Volume and open interest numbers are published by futures exchanges like the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE), among others around the world.
Remember that the most actively traded commodities of today are not necessarily the same as those of tomorrow. Action begets action in markets. When the oil market becomes highly volatile, it attracts more price speculators, which will increase both volume and open interest. If a commodity price remains quiet, and the trading range narrows, the falling potential for profits will deter speculation, which will naturally result in a decrease of volume and open interest in that market. Therefore, always pay attention to whether a market has sufficient liquidity and interest before taking the plunge and trading or investing in that asset.
What Are Some Factors in Liquidity?
Liquidity and activity are functions of price action. While some markets, like gold and crude oil, always attract a high number of market participants, lumber and frozen concentrated orange juice futures tend to always suffer from liquidity problems. Other commodities come into and go out of fashion over time. The supply-and-demand fundamentals for commodities can change liquidity. For example, if there is a sudden shortage of a commodity, and the price begins to move higher, it will attract speculative buying. On the other hand, if a market is suddenly hit with a huge supply, speculative selling will often appear. In both of these cases, volume and open interest are likely to rise.
In the world of commodities trading and investing, macroeconomic forces also play a role in liquidity. The great bull market in commodities that commenced in 2000 and lasted until 2014 attracted a great deal of interest to all raw material markets. The advent of new products, ETFs, and ETNs, brought new participants to markets. Prior to the introduction of these market vehicles, the only potential for trading and investing could be found in the physical or futures markets. ETF and ETN products increased volume and open interest in the futures markets as administrators, managers, and issuers of these products often use the futures exchanges to hedge risks associated with the new products that trade on traditional equity exchanges. The ETF and ETN products create the ability for arbitrage or spreading futures against the ETF/ETN vehicles to take advantage of price discrepancies.
Comparing current volume and open interest numbers to historical levels will help you understand whether a market offers both the potential and the liquidity necessary to make it a candidate for your trading and investing pursuits.