Commodity Trading Strategies (Commodities and Traders)

Commodity trading strategies involve buying and selling commodities in financial markets based on various analytical methods and market trends to generate profit. Commodity trading is the exchange of various commodities, such as agricultural products, crude oil, natural gas, and metals, via futures contracts, ETFs, forward contracts, options, and so on. Speculators can also bet on the price movement of various commodities via CFD contracts with online brokers. At the end of the article we provide you with several examples of commodity trading strategies.

Related: Futures strategies for sale

We depend on different commodities to power the global economy. No one nation or entity has all the commodities, which is why commodities are traded across the world. But what is commodity trading strategy, and how is it done?

Table of contents:

What are commodities trading strategies?

Commodity trading strategies involve various approaches for buying and selling commodities such as gold, oil, or agricultural products. These strategies typically aim to capitalize on price movements in commodity markets, utilizing techniques like fundamental analysis, technical analysis, and trend following. Successful commodity trading strategies often require a deep understanding of market dynamics, risk management techniques, and the ability to adapt to changing economic and geopolitical conditions.

What are commodities?

Commodities are raw materials used to manufacture finished items. Examples include agricultural products, such as cocoa, coffee, cotton, wheat, and sugar; precious metals, such as gold and silver; industrial metals, such as copper and steel; and fossil fuels, such as crude oil and natural gas.

They form the basis of our economy, as the raw materials are needed for the production of food, energy, clothing, and ornaments or even serve as a store of value.

What are some common commodity trading strategies for beginners?

Beginners often start with trend-following strategies, where they buy or sell commodities based on the direction of price movements over time. Another approach is mean reversion, where traders bet on prices returning to their historical averages after periods of divergence. Additionally, breakout strategies involve entering trades when prices break through predefined levels of support or resistance. Finally, fundamental analysis focuses on evaluating supply and demand factors to predict price movements.

How can beginners use technical analysis in commodity trading strategies?

Technical analysis involves studying past market data, primarily price and volume, to forecast future price movements. Beginners can utilize simple technical indicators like moving averages or relative strength index (RSI) to identify trends or overbought/oversold conditions. These tools help traders make informed decisions about when to enter or exit commodity trades based on chart patterns and momentum signals.

What role does risk management play in commodity trading strategies for beginners?

Risk management is crucial for beginners to protect their capital from substantial losses. This involves setting stop-loss orders to limit potential losses on individual trades, diversifying portfolios across different commodities or asset classes, and sizing positions appropriately based on risk tolerance. Beginners should also avoid overleveraging, as excessive borrowing amplifies both gains and losses, potentially leading to significant financial setbacks.

How can beginners use fundamental analysis into their commodity trading strategies?

Fundamental analysis involves evaluating factors such as supply and demand dynamics, geopolitical events, and economic indicators to forecast commodity price movements. Beginners can start by researching the specific fundamentals affecting the commodities they’re interested in trading, such as weather patterns for agricultural commodities or geopolitical tensions for energy commodities. By staying informed about these factors and their potential impact on prices, beginners can make more informed trading decisions aligned with underlying market fundamentals.

What does commodity trading mean?

Commodity trading is the exchange of various commodities usually via futures contracts, forward contracts, and options. While it is mostly engaged by real players in the industry who need physical delivery of assets, many speculators also bet on the price movement of various commodities.

Speculators also trade via CFD contracts with online brokers. If they believe the price of a commodity will rise, they buy certain futures contracts (or go long), and if they believe the price will fall, they sell other futures contracts (or go short).

Given the importance of commodities in daily life, commodity trading began long before modern financial markets, as ancient empires established trade routes for exchanging goods.

What are the different commodity trading exchanges?

In trading, commodities are regarded as a class of assets, which are bought and sold on exchanges, just like stocks.

Well-known exchanges include the Chicago Mercantile Exchange (CME), New York Mercantile Exchange (NYMEX), ICE, and London Metal Exchange (LME), which are the primary commodity markets.

These commodity markets allow producers and consumers of commodity products to gain access to them in a centralized and liquid marketplace. They ensure that the commodities are standardized for quality and quantity so they’re priced the same regardless of who produced them.

What is the evolution of commodity trading

Commodities are mainly traded via futures contracts. Both futures and forward contracts originate from the commodity market (several hundreds years ago).

In the past, commodities trading required significant amounts of time, money, and expertise, and was primarily limited to professional traders, but with the advent of the internet and online brokers, there are more options for participating in the commodity markets.

What are the motives and participants in the commodity market

Stakeholders in various industries, including governments, trade commodities to hedge future consumption or production, while speculators, investors, and arbitrageurs participate in the markets to make profits. Furthermore, certain commodities, such as precious metals, have been thought of to be a good hedge against inflation, and a broad set of commodities as an alternative asset class can help diversify a portfolio.

Because the prices of commodities tend to move in opposition to stocks, some investors also rely on commodities during periods of market volatility.

What are the historical context of commodity trading

Commodity trading has been around for a long time, even from the dawn of human civilization. Tribal clans and kingdoms would trade with one another for food, supplies, and other items. The rise of mighty ancient empires such as the Greece and Rome empires can be directly linked to their ability to create complex trading systems and facilitate the exchange of commodities across continents through routes like the famous Silk Road that linked Europe to Asia.

What are the different kinds of commodities?

Commodities are typically classified into four broad categories: metals, energy, livestock and meat, and agricultural.

Metals

These include precious metals, such as gold, silver, platinum, and palladium, and industrial metals, such as copper, zinc, and steel. Industrial metals are used in the industries, while precious metals are mostly used to make jewelry and ornaments. Investors can also buy precious metals to protect themselves from high inflation or a drop in the value of their currency.

Energy

Examples of energy commodities include crude oil, heating oil, natural gas, and gasoline. These are fossil fuels and their products, which are used to power our homes, industries, and automobiles.

Meat and livestock

Lean hogs, pork bellies, live cattle, and feeder cattle are common examples of livestock and meat commodities.

Agriculture

Corn, soybeans, wheat, rice, cocoa, coffee, cotton, and sugar are examples of agricultural commodities. They are sometimes referred to as soft commodities.

Environmental

This is a new class of commodities that take the form of non-tangible energy credits, the value of which derives from the needs of market participants to produce and consume cleaner forms of energy. The markets for these products came about because of governments’ restrictions on greenhouse gas emissions (GHGs).

Cryptocurrencies

These are digital currencies, such as Bitcoin, Ethereum, Solana, and so on. They are created using digital cryptography to process transactions in a decentralized manner — that is, outside the control of banks and governments.

How can you buy and trade commodities?

The most common way to trade commodities is by buying and selling contracts on a futures exchange. Futures contracts are standardized and can easily be traded by anyone. To trade futures, you must first open an account with a brokerage firm specializing in these trades.

Other ways of trading commodities include options, CFDs, physical commodity purchases, commodity pools and managed futures, and commodity stocks.

What are soft commodities?

Soft commodities refer to agricultural products that are grown rather than mined or extracted. These include crops such as wheat, corn, soybeans, coffee, sugar, and cotton. Unlike hard commodities like metals or energy resources, soft commodities are typically perishable and subject to weather and seasonal variations. They are traded on commodity exchanges and their prices are influenced by factors such as weather conditions, supply and demand dynamics, geopolitical events, and government policies. Soft commodities play a vital role in global food and textile supply chains, impacting economies and livelihoods worldwide.

What are hard commodities?

Hard commodities are tangible goods that are mined or extracted from the earth. They include natural resources such as metals (gold, silver, copper), energy resources (crude oil, natural gas), and agricultural products (wheat, corn, soybeans). Unlike soft commodities, which are grown and harvested, hard commodities are typically non-perishable and have intrinsic value. They are essential raw materials for various industries and play a crucial role in global economic activities. Hard commodities are often traded on commodity exchanges and can be subject to price fluctuations based on supply and demand dynamics, geopolitical factors, and economic conditions.

How can you trade commodities?

There are different ways you can trade commodities, depending on whether you want to take delivery of the asset or not. They include the following:

Spot trading: Here, the commodities can be delivered to their owners after purchase. But for gold, some vendors also offer custodial services, such that a buyer may own the physical product (bullion) without taking delivery of it.
Commodity futures: Futures contracts are agreements to purchase a set amount of a commodity at a time in the future. They are normally traded on the futures market before the purchase date and you can choose not to make/take delivery of the asset.
Options on futures: These are contracts that allow you to speculate on futures using less money, but you must know what you’re doing to avoid holding worthless contracts after expiry.
CFDs: CFDs or contracts for difference allow traders to speculate on the price of commodities without owning them. A CFD is a contract to exchange the difference in price between the time the trade is entered and exited.
Stocks: Stocks of companies that are involved in the mining or production of commodities offer an indirect way of trading the commodity market.
ETFs: You can also gain exposure to the commodity market through ETFs (exchange-traded funds) that invest in physical assets, commodity futures, options on futures, or shares of companies that mine or produce commodities.

What is the history of commodity trading?

Commodity trading is at least as old as the financial markets, if not older. The first organized exchange for trading commodities was established in Amsterdam in 1530.

What are the 10 most traded commodities?

The top ten most traded commodities in the world are:

Brent crude oil: This is one of the two major types of oil used to benchmark global prices, along with West Texas Intermediate (WTI). Brent crude is a high-quality ‘sweet light’ oil, meaning it has a low sulfur content, and thus, is relatively easy to refine into gasoline and other products. It is mostly gotten from the North Sea and Nigeria.
WTI crude oil: This is another high-quality sweet light oil. It has lower sulfur content than Brent crude. WTI oil is drilled in various US states, especially Texas, Louisiana, and North Dakota.
Steel: It is an alloy of iron and carbon but may include other elements such as manganese, chromium, nickel, and tungsten. Steel is an important commodity because it is extremely strong and relatively low cost. It is used in construction, infrastructure, and manufacturing.
Gold: This is a precious metal that is primarily used for jewelry production due to its shiny beautiful color. It is also used as an asset for investment because it is seen as a store of value.
Silver: As with gold, silver is a precious metal that has been highly sought after for thousands of years. A large proportion of demand for silver is driven by jewelers and investors. But a huge part of the demand can also be attributed to its industrial uses in making solar panels, photographic films, and electrical contacts.
Corn: Also known as maize, corn is an important agricultural commodity that provides food for both humans and animals. It is used primarily to produce animal feed, ethanol, corn syrup, and starch.
Soybeans: Also known as soyabeans, they are an important agricultural commodity that is rich in protein and relatively cheap to produce. Soybeans are used to make a variety of food and agricultural products, including soybean meal (animal feed) and soybean oil. They are also used as meat and dairy substitutes such as tofu and soy milk.
Copper: It is an important industrial metal given that it is an exceptionally good conductor of both heat and electricity, as well as being corrosion resistant and weatherproof, it is primarily used to manufacture electrical wire, pipes, roof tiles, and industrial machinery.
Aluminum: This base metal is exceptionally light and corrosion resistant. It is often combined with other elements to form alloys that are used in the production of vehicles and planes, packaging materials, and tools for construction.
Iron ores: These are the rocks and minerals from which iron can be extracted. While the vast majority of iron ores are used to produce pig iron, which is used in steel production, extracted iron is also used to produce cast iron, magnets, and catalysts for various industrial and chemical uses.

Commodity Trading Strategies

Let’s make one thing clear from the start: we have been trading and backtesting for over 20 years, and our conclusion is that commodities are very hard to trade. Part of this is explained in this chart that shows the DBC commodity index from 2006:

Since 2006 the index has risen only 11%! There is no long-term tailwind as you have in stocks. What is DBC? The ETF with the ticker code DBC tracks Brent crude oil, WTI crude oil, heating oil, gasoline, natural gas, gold, silver, aluminum, zinc, copper grade A, corn, wheat, soybeans, and sugar. Thus, it’s a benchmark of the commodities market. Compare the performance of commodities (DBC) to those of stocks (S&P 500):

Commodities have hardy had any gains since 2006 (and still negative since the top in early 2008), while stocks have multiplied. The reason is that commodities are not productive assets. Yes, they are used in everyday life, but on their own doesn’t produce any tangible value. Stocks, on the other hand, produce economic value and you can benefit from productivity gains (thus increased living standards) and be protected from inflation (in the long run).

Commodity Trading Strategy no 1 (Backtest)

Let’s start with a backtest that looks at the overnight edge: we buy the close and sell the open the next day in the ETF with the ticker code DBC. The equity curve looks like this:

Commodity trading strategy (overnight edge)

Just as in the stock market, all the gains have come from the overnight edge and not when the stock exchange is open. That said, the average gain is a tiny 0.02% per day, less than half what you see in the stock market. We trade many different trading rules to increase the gains, thus increasing the chances of curve fitting, but it’s tough to find a real trading edge in commodities.

Commodity Trading Strategy no 2 (Backtest)

Let’s backtest the simplest trend following strategy there is: the 200-day moving average strategy. We buy at the close when the close crosses above the 200-day moving average, and we sell at the close when the closes crosses below the 200-day moving average (a long strategy). This is how the equity curve looks like:

Commodity trading strategy (trend following strategy)

The CAGR (annual return) is a moderate 3.3%, but still substantially higher than the buy and hold of 0.7%. We did a strategy optimization for the moving average strategy, and the longer the average the better it performs. However, we can clearly see that’s this is not a tradeable strategy. Does it get any better if we add short trades? Let’s run the 200-day moving average by flipping the rules (we are invested 100% of the time either long or short):

Commodity trading strategy (trend following - long and short) — Commodity trading strategy (trend following – long and short)

As you can see, the trading strategy improves. The CAGR jumps to 8.2% and the profit factor is 2.3. Trading the short side adds a lot of value by smoothing the returns and lowering the drawdowns. We would say the strategy is hard to trade on its own but might work better in a portfolio of trading strategies. The most important thing in trading is to have many strategies that complement each other. If you have a loss in one strategy you hopefully have a gain in another one!

Commodity Trading Strategy no 3 (Backtest)

Let’s look at the turtle trading strategy. The strategy (strategies) is built on the famous turtle experiment conducted in the 1980s by Richard Dennis and William Eckhardt. Dennis said trading can be taught, while Eckhardt thought it couldn’t. Dennis won the bet. A group of random people was taught about trading and strategies for two weeks before they were given real money to trade. We won’t go into details about the strategies in this article, but instead, refer to what we have written about turtle trading strategies.

Our best commodity trading strategies

Here you can find all of our best Commodity Trading Strategies.

What is commodity trading, and how does it work?

Commodity trading involves buying and selling various commodities and their derivative products. Buyers and sellers come together on exchanges, such as the Chicago Mercantile Exchange (CME) and New York Mercantile Exchange (NYMEX), to exchange goods. Commodity trading can be for profit or to hedge risks.

How is commodity trading historically significant?

Commodity trading has roots dating back to ancient empires, establishing trade routes for exchanging goods. The first organized exchange for trading commodities was established in Amsterdam in 1530, making it at least as old as modern financial markets.

Can investors buy precious metals as a hedge against inflation?

Yes, investors can buy precious metals like gold and silver to protect themselves from high inflation or a drop in the value of their currency. Precious metals are often considered a store of value.

How do commodity trading strategies vary, and what are some examples?

Commodity trading strategies vary, and the website provides several examples such as the Gold weekend trading strategy, Trend-following system in gold, and strategies for trading and investing in oil stocks. The article “Commodity Trading Strategy (Backtest And Example)” summarizes these strategies.

What are some popular commodity trading strategies?

There are various commodity trading strategies, including “How Does Gold Perform When Inflation Is High?”, “Commodities to Equity Ratio Trading Strategy,” “Silver Futures Strategy,” “Platinum Futures Strategy,” “Corn Futures Strategy,” and more. Each strategy aims to capitalize on specific market conditions.

How can one trade commodities, and what are the different methods?

Conclusion

The commodity market is huge and is very influenced by macro factors and the overall economy. There are many different players in commodities: speculators, local traders, producers, sellers, arbitrageurs, hedgers, etc. One group is missing, though: long-term investors. There are many investors in productive stocks, but very few invest for the long term in commodities. Because of this, the commodity market is very different from the stock market and in our opinion makes commodities hard to trade. Our experience tells us that any commodity trading strategy is more likely to become unprofitable compared to a stock trading strategy. We trade silver, gold, oil, and natural gas, but many strategies tend to fail after a few years.

Commodity trading can be done through spot trading, commodity futures, options on futures, CFDs (contracts for difference), stocks of commodity-related companies, and ETFs (exchange-traded funds). Each method has its advantages and considerations.