Gold, sugar and oil. How do people actually trade and make (or lose) money from them?

Commodity trading is a niche area in the finance world that in recent years has been gaining more interest among individuals who are seeking alternative trading instruments from the usual stocks and bonds.

Commodities that are frequently traded in the financial markets are typically the ones that drive the global economy world that we live in.

These include important and precious metals such as gold, silver, copper, platinum, and energy commodities like oil and natural gas. Both metals and energies are considered as hard commodities, since they are mined or extracted.

Commodities such as wheat, sugar, corn and cocoa are known as soft commodities. Unlike hard commodities, they are products that are grown, rather than extracted or mined.

All commodities require time to produce and process before it is delivered from producers to buyers. This gives rise to two main forms of payment that producers and buyers can settle on.

Spot price is the price you pay for buying the commodityon-the-spot.For example, if a corporation wants immediate delivery of a barrel of crude oil today, they will pay the spot price, which is the current market price of the commodity today.

If a corporation requires the commodity in the future, but wants to have some future price certainty today, it can enter into a future contract with the producer. This is basically an agreement between the two parties for future delivery of the commodity for an agreed upon price.

Commodity trading in the financial markets work in a similar manner to the two ways mentioned above. Traders can trade commodities based on current spot price (e.g. Spot Gold, Spot Silver) and make, or lose, money depending on whether the price moves for or against their position.

Read Also:What Are CFDs And When Should Traders And Investors Use It?

Traders can also opt for a future contract as well. Unlike a spot position, a future contract will expire at a specified future date. The value of a future contract will be derived by how much the commodity is priced in the future contract, compared to the spot price at that point in time.

Future contracts are highly standardised and traded through dedicated exchange that ensures all contracts are marked-to-market daily.

Similar to all types of financial instruments, there are risks involved when it comes to commodity trading. Here are the 4 main risks that potential traders should be familiar with.

Since all traded commodities are used, the prices of commodities can swing widely based on whether demand excess supply, or vice versa.

For example, if a big country such as China were to expand its infrastructure development over the next few years, prices of traded metals are likely to increase.

For soft commodities such as wheat, cocoa and coffee, prices can increase if poor weather limits supply for a particular time period, since consumer demand for these goods are likely to remain constant.

Political developments can cause price fluctuations.

For example, if large oil producing nations in the Middle East are in a political turmoil, it may lead to a slowdown in oil supply, thus leading to oil prices increasing.

Like it or not, most commodities are priced in US Dollar (USD). For Singaporeans, what that means is that the performance of our Singapore Dollar (SGD) against the USD also matters to us, since any potential gains in our trades may be offset if the exchange rate moves against us.

One of the main reasons why financial traders are keen to trade commodities is because of price volatility.

Due to the various risks mentioned above, prices can fluctuate significantly in the short run thus allowing for profits to be made, assuming a trader takes the right position. By employing leverage, profit margin can increase further.

Read Also:How Does Leverage Trading Work In Singapore

Of course, the reverse holds true as well. Unexpected price volatility can lead to losses for traders who are on the wrong side of the trades. As such, it is important for traders to understand the commodities they trade, and the risks they are exposed to when they trade these commodities. Understanding these risks are what separates knowledgeable traders from those who are blindly speculating on price changes.

This article was sponsored byIG, the worlds No.1 CFD provider (by revenue excluding FX, 2016). All views expressed in the article are the independent opinion ofDollarsAndSense.sg

Find out moreabout how IG can help youget start trading indicestoday.

Aviva MyCoreCI Plan: Pros Cons Of Avivas Latest Critical Illness Plan, And How It Can Protect Those With Diabetes

How Much Does It Cost Singaporeans Who Want To Earn A PhD In Singapore?

HDB BTO Sales Launch May 2019 Locations And Analysis (Kallang/Whampoa; Woodlands; Tengah)

Refash, The Kint Story, StyleTribute: Heres Why Thrift Stores Are The Cheaper (And Better) Choice For Interns And Fresh Graduates

Retirement In Singapore: Heres Why You Need To Understand The Difference Between Your Net Worth And Income

Investing For Your Children: How You Can Help Your Kids Get Started On Investing

4 Stocks This Week (US-Play S-REITs) 10 May 2019 Kep-KBS REIT; Manulife REIT; ARA HTrust; Ascott REIT

The (Unexpected) Financial Challenges Of Having A Child In Singapore. A Singaporean Couple Shares Their Experience With Us

Heres What You Need To Know About The Latest Changes To CPF Usage And HDB Housing Loans When Buying Residential Properties

Here Are The Costs You Incur When You Choose Not To Invest

7 Useful Apps And Services Every Savvy Singaporean Should Already Be Using To Save Money

Standard Chartered Visa Infinite: Should You Apply For This Mass Affluent Credit Card (Even If You Dont Meet The $150,000 Minimum Salary Requirement?)

HDB BTO Sales Launch May 2019 Locations And Analysis (Kallang/Whampoa; Woodlands; Tengah)

Complete Guide To Using Your CPF To Pay For Your Private Property

GrabFood VS Foodpanda VS Honestbee VS Deliveroo: How You End Up Paying Different Prices For The Same Food Order

Which Would You Choose: An Annual Bonus Or A Salary Increment?

Heres What You Need To Know About The Latest Changes To CPF Usage And HDB Housing Loans When Buying Residential Properties

4 Ways Companies Can Pay Out Bonuses, And What You Can Do With It

Retirement In Singapore: Heres Why You Need To Understand The Difference Between Your Net Worth And Income

The (Unexpected) Financial Challenges Of Having A Child In Singapore. A Singaporean Couple Shares Their Experience With Us

How Peer-To-Peer Lending Supports Financial Inclusion

Step-By-Step Guide To Investing With Funding Societies In 2019

Top 5 Investment Articles That Singapore Investors Should Read In 2019

Top 3 Announcements From Budget 2019 That SME Owners And Entrepreneurs Need To Know About

Running Your Own Company? Here Are 5 Singapore Government Agencies You Need To Know About

How To Grow The Ang Pow Money Your Receive This Chinese New Year

Heres The Best Way To Start Adding P2P Lending To Your Investment Portfolio Before The (Chinese) New Year

5 Key Reasons Why Successful SMEs Take Business Loans

4 Top Finance-Related Issues Faced By SMEs In Singapore

Running A Small Business? Here Is What You Need To Know About Your Business Revenue And Expenses

This Is Why Some People Trade Rather Than Invest