How do commodity CFD markets work?

Understanding how commodity CFD markets work is vital for traders seeking to diversify their portfolios and gain exposure to the vast world of commodities. CFD markets provide an opportunity to participate in the fluctuations of commodity prices without having to own the underlying asset; it can be done instantly and completely digitally. This article will discuss how CFDs work, the potential benefits of trading the commodity market, as well as provide commodity market examples and how they are categorised.

How do CFDs Work?

As touched on above, Contracts for Difference (CFDs) are a type of derivative financial instrument that allow traders to speculate on the price movement of an underlying asset, such as commodities, without actually owning them. CFDs are essentially an agreement between two parties to exchange the difference in value of an asset between the time the contract is opened and when it is closed.

In commodity CFD markets, traders can trade on the price fluctuations of a wide range of commodities, such as oil, gold, and agricultural products. A key feature of CFDs is that they allow for trading on margin, which means that traders can control a larger position with a smaller amount of capital, this can be done with a CFD trading broker such as markets.com. However, it is essential to understand that this leverage also increases the potential risks involved in trading. If you would like to know more about CFDs you can learn all about them HERE.

Benefits of Trading the Commodity Market with CFDs

1. Diversification 

Trading in the commodity market is a great way to diversify a trading portfolio. Diversification is an essential part of trading best practice when constructing a portfolio as it reduces overall risk and the potential for unexpected trading outcomes. Diversification is the process of spreading risk across different asset classes and sectors to ensure that the performance of any one instrument does not have a significant impact on the overall portfolio's returns. Commodities tend to have a low correlation with other financial instruments like stocks and bonds, which makes them an excellent addition to a diversified portfolio. By trading in commodities, traders can reduce their overall portfolio risk . If you would like to know more about risk management and diversification outside of trading commodity CFDs you can visit our CONSUMER DUTY PAGE, our EDUCATION CENTRE or our BEST EXECUTION PAGE which explains all the order types at your disposal with markets.com.

2. Inflationary Protection

Commodities have historically been a hedge against inflation. As the prices of goods and services increase during periods of inflation, the prices of commodities also tend to rise. This is because the demand for commodities tends to increase during inflationary periods as traders seek to use them as a store of value. As a result, the supply cannot keep up with the demand. By trading commodity CFDs, traders can protect their portfolios from the negative effects of inflation. It is because of this inverse relationship that adding commodities to a portfolio can provide a historically proven safeguard against the erosion of purchasing power caused by inflation. This makes commodities a popular choice for trading during times of excessive price acceleration. However, it should be noted that anything can happen in the markets and past performance is in no way an indication of future results.

3. Flexibility

One of the most significant advantages of trading commodity CFDs specifically, is that it does not require the physical ownership of the underlying asset. This eliminates storage and transportation costs associated with physical ownership. Physical ownership of commodities can be costly and requires specialized knowledge and expertise. By trading commodity CFDs, traders can avoid the expenses of storing and transporting physical commodities and enjoy greater flexibility while trading. Trading in commodity CFDs is more convenient and less time-consuming than physical ownership, making it a favorable option for busy and fast-moving traders.

Commodity Market Examples and Categories

Commodities are typically classified into two main categories: hard and soft commodities. This distinction is essential for traders seeking exposure to the commodity markets, as it highlights the unique characteristics and price drivers of each group.

Hard commodities

Hard commodities refer to natural resources that are extracted or mined from the earth, such as precious metals, energy resources, and industrial metals. Examples of hard commodities include gold, silver, crude oil, natural gas, copper, and iron ore. These commodities play a crucial role in various industries and are often used as raw materials for manufacturing processes. The prices of hard commodities are heavily influenced by factors such as geopolitical events, supply and demand dynamics, and global economic trends.

Soft commodities

Hard commodities, on the other hand, encompass agricultural products and livestock. Examples of soft commodities include wheat, soybeans, corn, coffee, sugar, and cattle. These commodities are primarily used for human and animal consumption, and their prices are influenced by factors such as weather patterns, crop yields, and changes in consumer preferences. Unlike hard commodities, which tend to have longer production cycles, soft commodities often have shorter and more seasonal cycles, making them subject to more frequent price fluctuations.

Conclusion

Understanding how commodity CFD markets work is crucial for traders looking to dive into the dynamic world of commodities. Traders can gain exposure to a diverse range of assets, including oil, gold, and agricultural products. This not only allows for portfolio diversification but also offers the potential new trading strategies such as inflation hedging.

However, it is essential to recognize that trading CFDs also carries inherent risks that are only amplified due to the leveraged nature of the product. As such, traders should be well-versed in risk management techniques and ensure they fully understand the potential outcomes before entering the commodity CFD market. While this article has touched upon the basics of how commodity CFD markets work, further research and education are crucial to make informed decisions and to navigate the complexities of CFD trading successfully. Remember, the information provided here is for educational purposes and should not be construed as financial advice. It is essential to consult with a professional financial advisor or conduct thorough research before making any financial decisions.