What is Commodity Trading
Commodity trading is the process of buying, selling, or trading raw materials, or commodities, for profit. Commodities can be natural resources, such as oil, gold, or coffee, or agricultural goods, such as livestock or meat
What is the Difference Between Hard and Soft Commodities?
Generally speaking, hard commodities are those that are mined or removed from the earth. These may consist of petroleum products, metals, and minerals. Agricultural products and other grown commodities are referred to as soft commodities.
What Are Commodities?
Commodities are goods that are more or less uniform in quality and utility regardless of their source. Commodity goods are interchangeable, and by that broad definition, a whole host of products where people don’t particularly care about the brand could potentially qualify as commodities. Investors typically adopt a more specialised perspective, referring to a small number of fundamental products that are in high demand worldwide. Raw materials for manufactured finished goods make up a large portion of the commodities that investors concentrate on.
How Volatile Are Commodities?
Supply-and-demand dynamics are the main reason commodity prices change. When there’s a big harvest of a certain crop, its price usually goes down, while drought conditions can make prices rise from fears that future supplies will be smaller than expected. Similarly, when the weather is cold, demand for natural gas for heating purposes often makes prices rise, while a warm spell during the winter months can depress prices.
Commodity volatility is typically higher than that of equities, bonds, and other asset classes because to the frequent changes in supply and demand characteristics. Gold, a reserve asset that central banks use as a hedge against volatility, is one commodity that exhibits greater stability than others. However, other commodities frequently fluctuate between stable and volatile states based on market conditions, and even gold can become volatile at times.
How Can I Build a Diverse Portfolio In Commodity Trading?
Building a diverse portfolio in commodity trading requires strategic planning and careful consideration of market factors. Here’s how you can achieve it:
Invest Across Commodity Categories
Diversify your portfolio by including commodities from different sectors such as energy, metals, and agriculture. This minimises the impact of price volatility in any single category.
Balance Market Drivers and Regions
Spread your investments across commodities influenced by distinct market drivers, such as geopolitical events, weather patterns, or supply chain dynamics. Additionally, consider geographic diversification to offset regional risks.
Utilise Various Trading Instruments
Incorporate different trading instruments like futures, options, and commodity ETFs. Each offers unique advantages and can complement your overall strategy.
Understand Market Trends and Risk Tolerance
Successful portfolio construction requires a deep understanding of market trends and an alignment with your risk tolerance. Regularly review and adjust your investments to stay on track with your goals.
By diversifying strategically, you can reduce the impact of price fluctuations in any single commodity, creating a resilient and balanced portfolio.
How Do Commodities Diversify a Portfolio?
The addition of uncorrelated risky assets to a portfolio results in diversification. Commodities can offer some diversity because they typically have weak or negative correlations with equities and other asset types.
What Percentage of My Portfolio Should Be In Commodities?
Experts recommend around 5-10% of a portfolio be allocated to a mix of commodities. Those with a lower risk tolerance may consider a smaller allocation.