The Types of Commodity Trading Strategies Beginners Need to Know

Young woman analyzing computer data
•••

Tetra images/Getty Images

 

The commodity futures and options markets offer plenty of opportunities to profit from price movements. However, the most success is usually generated through the use of tested trading strategies.

There are a multitude of commodity trading strategies, some that have been through rigorous testing and others that have been developed by individual traders over time. For commodity trading beginners, it is wise to research the market, understand basic trading products, and test out some of the most basic strategies before risking any hard-earned capital.

Watching the financial news and reading commodity newsletters for the latest trading tips can be a good place to start. These resources provide a trader with information on the market environment as well as tips and skills for succeeding when trading commodities. Finding the right market trading platform is also a basic essential for beginning commodity traders.

Below are three of the most well-known commodity trading strategies any beginning trader might want to use. These strategies and generally many others will rely on the deployment of technical analysis which tracks price movements, moving averages, and many other technical metrics that can be identified through the use of a technical charting platform.

Technical analysis and technical metrics form the basis for most all trading strategies as they help to provide alerts on when a trader should enter or exit a position. Each trading strategy will have its own methodology for the incorporation of technical indicators and the trading guidance it provides.

Keep in mind a strategy framework provides a specific type of guidance and may be used in conjunction with other strategies for the most thorough decision analysis. Considering a full scope of factors will often generate some of the best results though this can create more complexity so traders may choose to focus on just one or two main signals.

Range Trading

Range trading is a strategy that is used in all types of financial market trading. It will often be built around Bollinger Bands or some other channel charting that graphs support and resistance levels. A range trading strategy involves buying at the support level when prices are at the bottom of a range and selling at the resistance level when prices are at the top of a range.

Bottoms and tops are heavily influenced by trading supply and demand. Prices of commodities usually approach their peak when demand pushes prices to a new high. This high levels off when traders feel the price has maxed out creating the expectation for a fall. Alternatively, prices fall to the bottom of a range when traders are selling and supply is increasing. Overselling or oversold territory can be important to understand when watching the bottom range as these terms mean the market price of a commodity is below its estimated value with a rebound likely to occur.

Overall, there can be several indicators to utilize when watching for overbought and oversold territory. In addition to using channel range charting, many traders also utilize the Relative Strength Index, Stochastics, Momentum, and Rate of Change. These indicators can be helpful when clear trends are hard to identify.

A range trading strategy can be very successful but also comes with some caveats. It is possible that markets may remain in overbought or oversold territory for long periods of time making it difficult to determine good timing for entry or exit. Also, support and resistance levels are only estimations. When using range trading, there is always the risk that a commodity’s price could move beyond an expected support or resistance level.

The chart below illustrates the ranges of gold prices for buying and selling.

Breakouts

A breakout strategy seeks to capitalize on short term movements. A trader using a breakout strategy will seek to gain from buying just before a commodity price moves substantially higher or selling just before a price moves substantially lower.

Breakout strategies can be used when range trading with specified support and resistance levels but they are not limited to just support and resistance level ranges. Breakouts may occur at any time. Identifying a breakout could help a trader profit from a substantial price move higher or lower.

The philosophy for trading breakouts is relatively simple. A market cannot continue its trend without making new highs or new lows. This strategy works best when trends are strong and long-lasting. It does not matter whether a trend is up or down, as the trader is buying new highs and selling at new lows. One critical caution for this strategy is that it performs poorly when markets are not able to establish strong, short-term trends.

Fundamental Trading

Fundamental trading is a strategy that can rely on both technical and fundamental indicators. Fundamental trading strategies look at market fundamentals that are usually based on idiosyncratic, market factors rather than technical trading dynamics.

For one example, a trader might buy soybeans because the weather is dry during the summertime leading to the expectation for an increase in demand from a smaller supply of the harvested crop. Another example could include the actual supply and demand for oil. If China announces an increase in their demand for oil, prices would be expected to increase and traders could potentially seek a long position to benefit from a breakout on the news.

One of the challenges with fundamental trading strategies is that it can require more time for research. Oftentimes, watching for technical chart patterns can be much easier than number crunching to develop fundamental forecasts. Moreover, fundamental positions may need more time and patience over the long term while technical patterns can provide faster gains when identified accurately.