Commodity CFD trading involves trading Contracts for Difference (CFDs) based on the price movements of commodities, e.g. metals such as gold and silver, energies such as crude oil and natural gas, and agricultural products such as wheat, coffee, or corn. CFDs allow traders to speculate on the price of these commodities without owning the physical assets themselves.
Commodity CFDs are popular because they allow investors to profit from price fluctuations in commodities markets without having to buy or sell the actual commodity. With CFDs, you can go long (buy) if you believe the commodity price will rise or short (sell) if you think the price will fall.
How Does Commodity CFD Trading Work?
When you trade a commodity CFD, you’re entering into a contract with a broker. Instead of buying or selling the actual commodity, you’re agreeing with your broker to exchange the difference in price from when you open the contract to when you close it. This allows you to speculate on price movements without owning the underlying asset.
For example:
- If you expect the price of gold to rise, you can open a buy position (long). If the price increases, you’ll profit from the difference between the entry and exit prices.
- If you believe the price of crude oil will fall, you can open a sell position (short). If the price drops, you’ll profit from the decline.
Example of a Commodity CFD Trade
Let’s say you believe that the price of Brent Crude Oil will increase due to a reduction in global supply.
- You decide to go long on a CFD for Brent Crude Oil at $80 per barrel.
- You use leverage of 1:10, meaning you control a $10,000 position with a $1,000 investment. The rest of the money is essentially borrowed from your broker to open the position.
- After two weeks, the price of oil has gone up to $85 per barrel.
- You decide to close your position and profit from the $5 increase per barrel. In this case, your total profit would be $5,000 ($5 per barrel x 1,000 barrels). However, had the price dropped to $75, you would have incurred a $5,000 loss.
Commonly Traded Commodities
Here are a few examples of commodities that you can speculate on using CFDs.
Precious Metals
Gold, silver, platinum, and palladium are popular precious metals for CFD trading due to their volatility and role as safe-haven assets.
Industrial Metals
Copper, aluminum, and zinc are a few examples of metals that are widely used in industrial production and available for speculation using CFDs. CFDs based on industrial metals are commonly used by traders looking to profit from economic trends or shifts in industrial demand.
Energy Commodities
WTI crude oil, Brent crude oil, and natural gas are all examples of frequently traded commodities. The energy sector is highly liquid and influenced by global events such as geopolitical tensions and natural disasters.
Agricultural Commodities
Wheat, corn, soybeans, coffee, sugar, and cocoa are examples of agricultural commodities that you can speculate on using CFDs. Prices are influenced by weather conditions, global demand, trade policies, and more.
Key Features of Commodity CFD Trading
Here are a few basic concepts that are important to understand for CFD traders.
- Going Long or Short
CFDs allow you to profit from both rising and falling markets. If you expect a commodity’s price to rise, you go long, and if you expect it to fall, you go short. You can go short without actually doing any classic short-selling (which would be much more risky, since you would be selling a borrowed asset). This flexibility is one of the reasons CFD trading is popular with active traders. - No Ownership of the Underlying Asset
When trading CFDs, you don’t actually own the commodity. This means you avoid the costs associated with storing physical commodities like gold, oil, or wheat. Instead, you’re only speculating on the price movement. With CFD trading, no one ever has the right to actually demand delivery of a commodity – or that their counterpart will actually buy a physical commodity from them. - Leverage
For many traders, one of the more attractive features of CFD trading is the ability to use leverage. Leverage allows traders to control a larger position than the capital they invest. For example, with leverage of 1:10, you can control a $10,000 position with just $1,000 of capital from your trading account. However, leverage amplifies both profits and losses, making proper risk management critical. In many parts of the world, financial authorities have limited how much leverage brokers are allowed to give to non-professional traders. Within the European Union, the European Securities and Markets Authority (ESMA) has limited leverage to a maximum of 20:1 for CFDs based on gold, and to 10:1 for CFDs based on other commodities than gold. This rule limits how much leverage the borker is permitted to extend to a non-professional trader (retail trader). It does not limit leverage for traders classified as professional traders.
Advantages of Commodity CFD Trading
- Profit from Rising or Falling Markets: Unlike physical commodity trading, CFDs allow you to profit from both price increases and decreases, depending on which type of CFD you buy (go long or go short). This gives traders more flexibility, which can be especially important during market downturns or periods of high volatility.
- No Physical Ownership: With commodity CFDs, you don’t need to worry about the logistics of storing physical assets like barrels of oil or bars of gold. You simply trade on the price movement, making it more convenient.
- Leverage: With leverage, traders can control large positions with a small amount of capital, offering the potential for significant profits. For example, with a 1:20 leverage ratio, you can trade a position 20 times the value of your initial investment. It should be noted that leverage increases both profits and losses, and adds another element of risk. You need to have an appropriate risk management strategy in place and stick to it.
- Lower Costs: Since you’re not dealing with physical commodities, you avoid many of the fees and costs associated with physical delivery, storage, and transportation. Additionally, most brokers offer competitive spreads (the difference between buy and sell prices) for CFDs.
- Access to a Wide Range of Markets: Commodity CFDs give traders access to a variety of global markets. Whether you’re interested in metals, energy, or agriculture, you can trade them all from a single trading platform.
Risks of Commodity CFD Trading
- Leverage Risk: While leverage can magnify profits, it can also amplify losses. If the market moves against you, losses can exceed your initial investment, making risk management essential. If Negative Account Balance Protection applies to your trading account, it is important that you also learn exactly how this work, and in which situations the broker will automatically close open positions for you.
- Market Volatility: Commodity prices can be highly volatile due to factors like geopolitical events, natural disasters, and fluctuations in supply and demand. This volatility can lead to large and sudden price swings, which can be challenging for traders.
- Financing Costs: When holding leveraged CFD positions overnight, traders often incur financing or overnight fees. These fees can add up over time, particularly if you hold positions for an extended period.
- No Ownership of the Asset: Since you don’t own the actual commodity, you won’t benefit from any intrinsic value changes. You’re purely speculating on price movements.
- Counterparty Risk: CFD trading is generally done with a broker, so you’re exposed to the credit risk of the broker. If the broker goes under, you could potentially lose your position or face delays in receiving your funds. It’s important to choose a reputable and regulated broker to mitigate this risk. In some countries, there are governmental insurance plans in place to protect traders and investors when brokers become insolvent, and they will typically pay out up to a certain amount of money per individual.
How to Start Trading Commodity CFDs
- Strategies Develop a trading strategy and risk management strategy for CFD commodity trading. Decide which commodity you want to trade, e.g. gold, natural gas, or wheat. Decide if you want to use technical analysis or fundamental analysis to inform your trading decisions. Establish clear entry and exit points, and how to use stop-loss and take-profit orders. You can start with something simple and then adjust your strategies later as you become more skilled and might wish to take on more comlex tasks.
- Choose a BrokerSelect a reputable and regulated broker that offers commodity CFDs. Make sure the is authoritzed to operate in your country. It is also important that the broker provides competitive spreads and a price structure that is suitable for the specific commodity and trading strategy you’re interested in.
- Demo Account Before you make any deposit, sign up for a free demo account and use it to explore the trading platform. You might find that the trading platform offered by this broker is not to your liking, and this is something you want to know before you have made any deposit. Also use the demo account to test out your trading strategy and risk management strategy, and adjust them if needed. It can be tempting to skip these steps, but learning how a platform works, see if it is suitable for your needs, and testing your strategies are really important steps that can save you a lot of trouble in the long run.
- Real Money Account Sign up for a real money account with your chosen broker. If there are several account types available, make sure you pick one suitable for your CFD trading strategy. Complete the Know Your Customer (KYC) procedure and make your first deposit.
- Start Trading You have already used the demo account to learn how the trading platform works, so you can now start doing real-money trades.
Questions and answers
Is there a leverage limit for Commodity CFDs in the UK?
Yes, the Financial Conduct Authority (FCA) in the UK is limiting how much leverage a broker is allowed to offer non-professional CFD traders. The limits are 20:1 for CFDs based on gold and 10:1 for CFDs based on other commodities than gold.
The FCA also requires that the broker close out a non-professional traders position if the trader´s funds fall to 50% of the margin needed to maintain their open positions on their CFD account. The broker must guarantee that a non-professional trader can not lose more than the total funds in their CFD account. These two rules are not only for Commodity CFD trading; they pertain to all CFD trading and for CFD-like options trading.
What is the difference between Brent Crude Oil and West Texas Intermediate (WTI)?
The two major benchmark prices for purchases of crude oil on the global market are Brent Crude Oil and West Texas Intermediate (WTI). Since the autumn of 2010, the price of Brent has been notably higher than the price of WTI.
Brent Crude Oil is the main global price benchmark for Atlantic basin crude oils, and it is used for roughly two-thirds of the world´s internationally traded crude oil. The name Brent is derived from the Brent oilfield in the North Sea, where this type of Atlantic basin oil was first extracted in the 1970s. Colloquially, the Brent Crude price usually denotes the price of Intercontinental Exchange Brent Crude Oil future contracts.
It is not only crude oil from West Texas that can be sold as West Texas Intermediate (WTI). Any oil can be sold as WTI as long as it meets the required WTI qualifications. In colloquial use, the WTI price usually refers to the price of WTI Crude Oil futures contracts traded on the New York Mercantile Exchange (NYMEX).
Examples of notable crude oil price benchmarks that are neither Brent nor WTI are Dubai crude, Oman crude, and the OPEC reference basket.
WTI crude oil is lighter (lower density) and sweeter (lower sulphur content) than Brent crude oil, and both WTI and Brent are lighter and sweeter than Dubai crude and Oman crude.