Supply and demand: Key factors in commodities trading

When you decide to trade, particularly with financial assets such as commodities, it becomes crucial to understand the fundamental factors that can impact their market prices. This knowledge can significantly enhance your chances of achieving successful trading outcomes.

In this trading article, we will find out why demand and supply affect the value of commodities, what impacts the supply and demand dynamics, common mistakes you need to know and what strategies are best for commodities trading.

What is commodities trading? 

Commodities trading is a financial activity that involves buying and selling raw materials or agricultural products.

Commodities are divided into two main categories: hard and soft commodities. Hard commodities include metals like gold, silver, and copper and energy products like oil and natural gas. Soft commodities, on the other hand, encompass agricultural products such as corn, wheat, soybeans, and coffee.

You can trade soft or hard commodities in various contract-for-difference (CFD) platforms through futures contracts and exchange-traded funds (ETFs). These instruments allow you to speculate on the future price of a commodity without physically owning it. Instead, you can buy or sell contracts representing the underlying asset’s value.

Here's an interesting read for you: How To Trade CFDs On Commodities
 

Dynamics of supply and demand in commodities trading

Supply and demand are fundamental concepts in commodities trading. They play a vital role in determining the price of a commodity and can provide valuable insights for traders. 

Supply refers to the amount of a commodity available in the market, while demand represents the desire or need for that specific commodity.

The interaction between supply and demand creates a bearish or bullish market. When supply exceeds demand, prices decrease as sellers compete to attract buyers. Conversely, when demand surpasses supply, prices typically rise as buyers compete for limited resources. 

Traders who understand these dynamics can use supply and demand analysis to make informed decisions and identify potential trading opportunities.

Consider giving this a look: What Is A Bull Market? A Complete Beginner’s Guide to learn more on the terms bullish and bearish. 

3 major factors affecting the supply of commodities 

In this section, we’ve compiled the essential factors that can impact the supply of commodities in the market. Carefully consider each aspect, as they can be invaluable when you eventually engage in trading.

1. Production levels

This element is affected by weather conditions, technological advancements, or geopolitical events. For example, a drought can decrease crop yields, affecting the supply of agricultural commodities like wheat or soybeans. Similarly, political unrest in an oil-producing country can disrupt oil production, affecting the supply of crude oil.

2. Transportation and infrastructure 

Efficient transportation networks and storage facilities are important for ensuring the smooth flow of commodities from producers to consumers. Any disruptions or bottlenecks in transportation can limit the supply of commodities and impact prices.

3. Government policies and regulations 

For instance, export restrictions such as tariffs imposed by a country can reduce the availability of certain commodities in the global market. Conversely, policies that promote production and trade, like free trade agreements, can increase the supply of commodities.

3 primary factors influencing demand for commodities 

Let’s analyse various factors, including economic growth, population trends, and consumer preferences and learn how they affect the demand for commodities.

1. Economic growth

As economies expand, raw materials and energy demand increase to support infrastructure development and manufacturing activities.

For example, China’s rapid economic growth over the past few decades has been accompanied by extensive infrastructure development, including the construction of the high-speed rail network, the expansion of its road system, and the development of megacities. These projects have driven significant demand for construction materials and energy resources.

2. Population trends

Growing populations require more food, leading to increased demand for agricultural commodities such as grains (wheat, rice, maise), oilseeds (soybeans, palm oil), and livestock products (meat, dairy).

3. Consumer preferences

Consumer’s choice of sustainable energy sources can drive demand for renewable energy, like solar panels and wind turbines, while reducing demand for trading oil and natural gas.

In addition, a shift towards healthier eating habits may increase the demand for organic food products, increasing the price of the commodities. 

Common mistakes to avoid in commodities trading

Commodities trading can be a complex and volatile market. To succeed, traders must avoid common mistakes leading to significant losses. 

One common mistake is failing to conduct thorough research and analysis. It would be best to stay informed about the latest market trends and news affecting the price of commodities you want to trade. With proper research, you may avoid exposing yourself to unnecessary risks in trading. 

Another mistake is overtrading. Some traders make frequent trades, hoping to take potential profit from small price movements. However, excessive trading can increase transaction costs and emotional stress, negatively impacting profitability. It would help if you focused on quality trades based on well-reasoned analysis rather than trying to chase every market fluctuation.

A lack of risk management can lead to significant losses. You should set precise risk tolerance levels, use stop-loss orders to limit potential losses and diversify your portfolios to spread risk across different commodities. It is essential to have a well-defined risk management strategy in place to protect capital and minimise losses. 
 

Most useful strategies for trading commodities 

The supply and demand dynamics can give traders valuable insights to develop effective trading strategies. Here are some helpful techniques you can adapt and use for trading:

• Trend following: This involves identifying and following significant trends in commodity prices. You can analyse historical price data and use insight-driven tools to identify trend reversals and entry/exit points.
• Mean reversion: In this type of trading, traders assume that prices will eventually return to their average or mean value. When a commodity’s price deviates significantly from its average, traders may take positions anticipating a price correction.
• Spread trading: This technique involves simultaneously buying and selling related commodities to take probable profit from price differentials. You may use technical tools to identify commodities with a historical price correlation and take advantage of temporary price imbalances.
• Fundamental analysis: This technique can assess a commodity’s long-term supply and demand fundamentals. You may analyse factors such as production levels, consumption patterns, and news and analysis from brokers to make informed decisions about the future direction of a commodity’s price.

Learn more about commodities trading at markets.com 

Supply and demand are fundamental factors in commodities trading. A grasp of what they are all about gives you an advantage in trading. 

Factors influencing supply, such as production levels, transportation infrastructure, and government policies, can impact the availability of commodities in the market. 

Similarly, aspects affecting demand, including economic growth, population trends, and consumer preferences, can drive the need for a particular commodity.

It would be best to learn more techniques to succeed in commodities trading. At markets.com, you’ll get access to various educational resources to help you become a skilled trader. 

The platform offers a selection of more than 20 popular commodities frequently traded by experts. 

Join our community and learn to trade with markets.com. 

When considering "Commodity CFDs" for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.