Commodities

Perhaps the easiest way for small traders to acquire exposure to metals and commodities such as crops is via spreadbets. Spread betting brokers quote prices for a wide range of the more common precious and industrial metals such as gold, silver, uranium, palladium as well as agricultural commodities such as corn, coffee, cocoa, coffee, cotton, oats and soya produce, wheat, as well as fuel like brent crude and gas. You can either spread bet on the commodity itself, or, in particular circumstances, on the exchange-traded product tied to it. Personally I have made a good amount of money from commodities, namely some low trades and high returns on Gold. Commodities are not difficult to trade, providing you know which is which and that you understand that the fundamentals that affect the price of commodities and stocks differ. In particular, commodities are influenced by the weather and trade, fiscal and monetary control policies, which do not affect stocks. Accordingly, commodities tend to be a valuable source of diversification especially when market trends are particularly uncertain. Of course both stocks and commodities are affected by World events like wars and economic up/downturns but for commodities the impact on prices could be dramatic. Let’s look at what commodities are and how we can make good profit trading them.

Spread Betting on Oil by Spreadex

Commodities were the first Futures markets products. I mention Futures a great deal with regards to financial spread betting. Fundamental differences apply, namely we are not trading ‘real’ Futures contract as such. We are trading using a tool that is related to financial spread betting, in the fact that the prices that we get quoted are linked highly to those of the Futures’ markets. Yet without the same amount of risk involved with Futures.

Futures products first appeared in the 19th century as a means for businesses to buy or sell a large quantity of a particular mass product (wheat, sugar etc.) and fix the price for delivery in the future – hence the name.

Why do this? Businesses as we all know, run on their own internal revenue. The ability to lock in prices for a future delivery of a product they use, would help them maintain and monitor production costs and effectively prices to Mr & Mrs Joe Public.

It soon became apparent that a great deal of money could be made (and lost) with trading these contracts, by locking in a price. When a price dropped and the contract was sold – you could buy to close the contract and make a fortune. Or, if indeed you opened a sell contract and bought to close, the gearing can make, or lose you a great deal of money. The risks with Futures trading are much higher than they would ever be when we trade in financial spread betting. For one, trading the futures markets would require capital outlays that are way too much for most private investors to afford. However as far as the gearing and the profitability of the Futures and that of financial spread betting there is little difference on that respect. In addition whereas futures traders have to pay tax on any gains they make, spread betters don’t have to pay a penny as spread betting is tax free. And while most crop futures are priced in dollars, all your exposure will be in pounds sterling.

The key difference with actually trading ‘real’ Futures is that the contract you take out, if left to expire, would mean that you would be responsible for the purchase/sale of those products. Not great if you’re trading, as the deposit on Futures is a fraction of the real cost. I don’t think anyone would like a tanker load of oil being delivered on his or her doorstep – that’s an awful lot of oil.

There has been a great deal of changes since those early days and that of the Financial Futures markets has overtaken commodity Futures trading easily. Having said that, there still exists a great deal of opportunity for those wishing to trade in financial spread betting within the commodity markets.

Each commodity has its own character which is why it is important to specialise and study such markets. Most commodities have a tendency to remain pretty static over time, then just when you were getting bored at the whole static nature of them, they double almost overnight.

Agricultural commodities cost more to spread bet, than, say, index markets like the FTSE or Dow – although for the more popular spread betting commodity markets like oil or gold, spreads are quite tight. To trade corn – one of the cheaper soft commodities in terms of trading costs – the difference between bid and offer prices could amount to several times that on the FTSE 100. And the spread for something less traded, like oats, would be even wider still. Having said that, the cost in absolute terms is small, a good deal less than 1% of the price even for more expensive contracts.

Most commodities cost more to spread bet, than, say, equity indices. To trade corn – one of the cheaper ones – the difference between bid and offer prices could be several times that on the FTSE 100. And the spread for something less mainstream, like oats, would be even wider. Still, the cost in absolute terms is small, a good deal less than 1 per cent of the price even for dearer contracts.

Note also that while agricultural spreadbets are based on the underlying futures prices, you won’t be able to trade the selection of contracts that are available in the futures markets. In short, you may be limited to trading a single contract: the one that expires closest to the present time which means that you might not be able to execute advanced strategies like simultaneously selling March corn and buying June corn.

There are more risks trading in commodities in financial spread betting. If you are not careful you can find that you are unable to close a losing trade and have to let it run. Why?

Most of the markets use a system of price limits that will lock you in to an open position, to which you must honour. The commodities that these vary on depend on whom you’re trading with. Should you be concerned as to the possibility of being locked in, I would suggest that you trade only used a Controlled Risk Bet, otherwise known as a Guaranteed Stop Loss.

Stick with markets you know. It can be tempting to spread trade some of the more exotic assets such as gold or pork bellies but there’s no point trading markets you don’t understand. You wouldn’t drive blindfolded: stick with what you know.

Example of a Commodity Bet

Tom Technician has watched the gold price break out from its 40 day trading range and now believes a trend change is possible in the yellow metal.

His spread betting company is offering a spread of $1402.3/$1403.3 for September gold. Tom decides to make a £50-a-point up-bet from $1403.3.

Shortly after the trade, a major continental Asian central bank commences buying physical of gold, and the September spread shoots up to $1494.3/$1495.3.

Tom operates a strict policy of letting profits run with a trailing stop loss. His stop-loss level, decided at the outset of the bet was 1380 is now moved up to 1480.

A week later, the spread on September gold falls to $1480.3/$1481.3, on the back of large selling orders.

Tom’s trade is closed at 1480.3 giving him a profit of £3850. [1480.3 – 1403.3 x 50]

Diversification with Commodities

Commodities present an interesting vehicle for diversifying your investment portfolio, because of their high correlation to inflation. The high volatility of most commodity markets, coupled with their low correlation to shares and bonds means that including exposure to commodities will help reduce overall portfolio risk without significantly reducing expected returns.

Inflation by itself is a measure of changes in commodity prices and the prices of commodities tends to rise when inflation accelerates. The negative performance of stocks during periods of high inflation will be balanced by commodities’ positive one. In other words, commodities can serve as an inflation hedge.

Most people that hear of Financial Spread Betting don’t realise for various reasons quite how easy and profitable it can be, but also the variety of differing products to which you can trade within. One such product that is gaining more and more popularity is trading in UK House Prices.

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