What Makes for Good Commodities—and How to Trade Them
When commodity traders are looking for somewhere to park their money, they usually select just a few commodities, based on their tolerance for risk, available capital, and professional knowledge. The actual trading of commodities involves more than dabbling in the stock market, so be prepared to devote some time to educating yourself not just on the commodity itself, but how it moves within the market. Since commodities are highly volatile, it's wise to develop your emotional health, as this is usually a significant factor trading in the commodities realm.
If possible, start with commodities in which you might already possess some professional knowledge. After that, it's a good idea to evaluate, then re-evaluate, your propensity for risk.
How to Select Good Commodities to Trade
Most professional traders concentrate on one, or just a few, commodities to trade. There is sound logic behind this approach as you intimately get to understand all the little quirks of a commodity that many traders miss.
Popular trades are in oil and gold, but alternative, less exciting options remain in corn and soybeans. Coffee futures can be traded for a quick scalp, because market sentiment can change drastically in a short period of time.
For day trading purposes, many trade oil and the e-mini S&P. Oil is a particularly popular trade on Friday, when the CFTC Crude Oil speculative net positions are revealed, and when Baker Hughes reports its U.S. oil rig count.
You can’t beat the liquidity in these markets, and there is no absence of trading opportunities here. There is, however, the price of liquidity: the crowding of popular trades.
Overall, it's best to trade liquid commodities, as certain trading setups will occur with greater frequency. Markets and trading conditions are constantly changing, so some commodities may offer good trading opportunities one year but not the next. Commodities also demand a day-to-day monitoring, since global supply can change within minutes.
Industry Knowledge About Commodities
Without much thought, you probably already have some good knowledge of at least one commodity through your living or working life. Some common tradable commodities and their trading symbols are as follows:
- Gold (GC)
- Crude oil (WTI)
- Rough rice (ZR)
- Corn (EMA)
- Wool (ASX)
Commodities are essentially raw materials, making up the goods that people manufacture, transport, and consume.
For example, truck drivers watch diesel and gasoline prices on a daily basis. Those who produce any candy or sweet goods are very in tune with the price of sugar. Construction businesses keep a close eye on the price of copper and lumber. If you have experience with commodities through related work, focus on commodities where you already have a basic understanding.
Volatility of Commodities
Next, you want to make sure that any commodities you trade fall into your risk parameters. Some commodities make small moves each day, while others make wide swings.
Realize also that not all commodities have equal risk. Make sure the amount of risk is suitable for you when you pick a commodity to trade. This is vital, since commodities experience exceptional price movement on even the rumor of important news.
To determine the volatility of each commodity, check the futures margin. This is the amount that futures exchanges require as a good-faith deposit on each futures contract you open. The margin is based on a variety of factors, but it mostly has to do with the daily price swings of futures contracts. The exchanges also change these values when market conditions change, which means close attention is mandatory.
You might not be able to trade some commodities. If you only have a $5,000 account, you will not be able to hold a futures contract that requires a margin of $7,500. So, you can rule out those commodities unless you trade futures options, which is an even riskier trade, and one that shouldn't be considered until you have tested well in simulated trades, and have achieved professional levels of emotional control and trading insight.
Some commodities aren't very active and are difficult to trade. Liquidity should be a consideration. It's a bad place to be when you can't exit a trade that no longer shows favorable conditions.
Pork belly, rice, lumber, orange juice, oats, and feeder cattle are commodities many traders shy away from for liquidity reasons.