The terms commodity trading is often heard in the news or seen in business sections of newspapers. Mystified and confused, many are left wondering what this terminology really means. This article directed at clarifying commodities for beginners will hopefully clear up some of the confusion.
This form of trade is also known as futures trading. Different to other types of trading, such as share dealing or art investments, in many instances it is really a case of speculating on the expected price that a commodity may be at a future date. It is closer to betting on the movement in which a price is expected to move.
A view of understanding a commodity is to see it as the raw material we use to uphold day to day life by producing goods and resources. This encompasses a lot but that is the reality of the commodity business. It includes a range as wide as rice in a paddy field to metals like iron and aluminum, or the building blocks of energy: natural gas and oil.
There are three important aspects to consider. Firstly it must be something tangible with which to trade. Secondly it must be a deliverable item. Thirdly there must be liquidity through the presence of a seller and a purchaser. Imagine a farmer with a large herd of cattle being reared for the beef market. Recent market dips and peaks have raised concerns about prices. A large fast food outlet makes an offer at a price considered reasonable, and the farmer agrees to supply 3000 head of cattle at a fixed price per kilogram.
A supermarket chain becomes concerned about shortfalls of rice on the market and the effect this may have on prices. The manager decides to approach a farmer and negotiates to purchase 5000 tons for delivery in 4 months time. Thus a contract for a commodity or futures is created. Each party is secure with the knowledge that regardless of how prices might move in the period up to delivery the supermarket will pay nothing more for the rice and the farmer get paid nothing less.
Obviously there is a bit more to it than this. Some of the instruments and methodology used to buy, sell and often resell contracts are quite complex and advanced. But as a first step for explaining commodities for beginners, and using simple examples, it really is not too difficult to gain an understanding.
This form of trade is also known as futures trading. Different to other types of trading, such as share dealing or art investments, in many instances it is really a case of speculating on the expected price that a commodity may be at a future date. It is closer to betting on the movement in which a price is expected to move.
A view of understanding a commodity is to see it as the raw material we use to uphold day to day life by producing goods and resources. This encompasses a lot but that is the reality of the commodity business. It includes a range as wide as rice in a paddy field to metals like iron and aluminum, or the building blocks of energy: natural gas and oil.
There are three important aspects to consider. Firstly it must be something tangible with which to trade. Secondly it must be a deliverable item. Thirdly there must be liquidity through the presence of a seller and a purchaser. Imagine a farmer with a large herd of cattle being reared for the beef market. Recent market dips and peaks have raised concerns about prices. A large fast food outlet makes an offer at a price considered reasonable, and the farmer agrees to supply 3000 head of cattle at a fixed price per kilogram.
A supermarket chain becomes concerned about shortfalls of rice on the market and the effect this may have on prices. The manager decides to approach a farmer and negotiates to purchase 5000 tons for delivery in 4 months time. Thus a contract for a commodity or futures is created. Each party is secure with the knowledge that regardless of how prices might move in the period up to delivery the supermarket will pay nothing more for the rice and the farmer get paid nothing less.
Obviously there is a bit more to it than this. Some of the instruments and methodology used to buy, sell and often resell contracts are quite complex and advanced. But as a first step for explaining commodities for beginners, and using simple examples, it really is not too difficult to gain an understanding.
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