Traditionally, investing in commodities has been regarded as complicated, time consuming and ill-suited to novice investors. That picture is starting to change and the commodities market is no longer the sole preserve of professional traders. Nonetheless, a decent grasp of the fundamentals is still vital. Read our quick, easy to digest guide to get a handle on the basics.
If you’re ready to invest, select the commodities you want to take a closer look at below. If you don’t feel ready, read on.
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Ready to invest? Click the links below to choose the type of commodity you want to learn about and invest in. Once you’re ready to trade, we’ll help you find a broker you can trust.
What are commodities?
Commodities are items that can be found in nature, which is why commodities trading is one of the longest-standing investing methods in the world, going back centuries. Commodities can be bought, sold, and traded, just like stocks, bonds and other assets. Note the distinction between buying and trading commodities: Buying commodities requires you to actually find a place to store the bushel of wheat or barrel of gas you want to own, whereas trading commodities involves using futures contracts to speculate on the price of said commodities, without actually owning them.
How to buy commodities in 7 simple steps
Before you start buying, read up on the variety of different commodities and investment types available to you. From there, we’ll walk you through the rest of the process, via these seven easy steps:
- Learn the basics. Get to know the types of commodities, and the various options within each type. Learn the various ways you can trade and invest in commodities. You’ll also want to learn some of the key terms that go with commodities trading, such as basis, convergence, and stop-loss orders.
- Learn how commodities work. Commodity prices rise and fall based on supply and demand. With that in mind, familiarize yourself with how global markets work, so you can understand how a bumper crop of wheat or an attack on a Middle Eastern oil field could affect which way prices go.
- Decide your budget. Since you’re just starting out, it might be a good idea to venture a smaller amount at first, say £500-£1,000. You can always invest more later. Whatever your budget is, stay disciplined when it comes to managing the size of your trades, and not putting in more than you can afford to lose.
- Choose your investment type. Some of the investment options available for commodities trading and investing include futures contracts, exchange-traded funds, mutual funds, individual stocks, and buying a certain amount of the commodity itself. We go into more detail on all of these below.
- Select a commodities broker. When choosing a broker, look for one that’s fully licensed, with a strong reputation and an easy-to-use platform. The right broker makes it easier, not harder, to trade commodities successfully.
- Assess the state of financial markets. As exciting as commodities trading can be, in a roaring bull market for stocks they could end up underperforming equities. Keep tabs on not only commodities markets but also the stock market to find an optimal time to jump in.
- Make your trade. Log into your online brokerage account, select the specific commodity and investment type you want to pursue, and click Buy. It’s as simple as that.
How to buy, sell, and trade commodities for beginners
The kinds of transactions you make in the commodities market should depend on your investing goals. Are you trying to make a quick profit, or are you planning a longer-term investment? How much risk are you willing to take? Let’s review how buying, selling, and trading commodities work, vis-a-vis those different goals.
This is when you buy a tangible amount of the actual commodity. Set a bid price, then see how large the spread is between your bid price and the ask price of potential sellers. You can also place a bid in cases where the seller is not looking to sell, which is called unsolicited offer, or unsolicited bid.
This is when you decide to close your position by unloading the commodity you’re holding. There are two reasons you might choose to sell. First, you might want to cash in, securing your profit rather than risking the price of the commodity crashing back to Earth. Second, you might want to cut your losses, selling quickly to avoid further damage. For extra caution, you can put in a stop-loss order, so that if the price of the commodity you bought falls by a certain amount, an automatic sell with happen and your capital will be protected.
If you don’t want to deal with the hassle and (in some cases) potential perishability of physically owning a commodity, you can choose to trade futures instead. Commodities futures are agreements to buy or sell a raw material at a specific date in the future at a particular price.
Types of investments and ways to invest
Figured out what kind of commodity you want to buy, but not sure how you want to do it? Let’s run through some of the different commodities trading methods, so you can figure out which one suits you best.
- Commodities themselves. The simplest of all commodities transactions, you’re buying the gold coins, live cattle, or other commodity you want to own. Aside from the usual price volatility that goes with any kind of commodity transaction, you also have to absorb the risk involved with storing the actual commodity that you own, be it in the form of theft, or potential spoilage.
- Commodity futures. Trading commodities futures entails betting on the price direction of a commodity, but without owning the commodity itself. To fare well at trading, you’ll want to learn how to read charts and look for technical cues to buy and sell. Trading commodities can be done by beginners, but you should avoid trading commodities futures with big money until you’ve gained more experience and expertise.
- Exchange-traded funds. Also known as an ETF, this is a type of security that includes a collection of securities. A commodity ETF can be focused on a single type of commodity, or it can be a collection of commodities futures bundled together. In either case you’re buying in bulk, thus diversifying your investment and limiting risk.
- Stocks producing commodities. Whether it’s an agricultural giant like Archer-Daniels Midland or any number of companies that do business in precious metals, oil, various foods, or other assets, a commodity stock lets you bet on the price of a commodity, but with all the usual trappings that go with buying stock. If you have any experience buying stocks, this will be one of the easiest and most familiar ways to play the commodities investing game.
Whichever of these options you choose, find a reputable broker to execute your trades. While you can find certain commodities like gold at a pawnbroker, we don’t recommend going that route, since the quality of the product you’re buying could be in doubt.
Before you take the plunge, we suggest reading our helpful guides and courses. Once you’re ready, click on the above links to get started.
Our top tips for investing in commodities
You now have a broad overview of how to invest in commodities. Here’s a quick rundown of key points.
- Manage your risk. Placing a stop-loss order when you buy a commodities contract will limit your losses if the trade doesn’t work out as you expected. You can choose to limit your maximum loss to 5%, 10%, or whatever threshold works best for you.
- Stick to a plan. Whatever approach you want to take, be consistent. Deviating from a well-constructed plan and trading on gut feel could torpedo your results.
- Don’t fall victim to emotions. Fear and greed can cloud your judgment. Make sure you’re making rational decisions, rather than letting emotions sway your investment decisions.
- Evaluate the market. That includes the state of various commodities, as well as other forms of assets. Opportunity cost is the loss of potential gain from other investment alternatives when you choose another instead. Make sure that you’re investing in commodities, that’s the right choice for you.
- Consider trading with leverage. Commodities brokers will allow you to trade with leverage, which is when you put down a portion of the investment cost, and the broker covers the rest. If the price of your commodity contract goes up, you’ll make a bigger gain than if you only ventured your own money. Just be aware that the potential downside is also greater if the commodity’s price falls.
Unsure which commodities to invest in?
Not sure where to go from here? That’s normal. Here’s a small checklist to help you.
- Budget size. If you’re starting with a small budget, consider a longer-term investment to start. The reason is simple: If you have less than £1,000 at your disposal and try to make frequent trades, the transaction fees alone will eat up a significant percentage of your bankroll. With a larger budget you can branch out, whether that’s into frequent commodities futures trading, buying actual commodities, or investing in commodity stocks, mutual funds, and ETFs.
- Risk assessment. Manage your risk as closely as possible when you’re just starting out as a commodities investor. You can do that with stop-loss orders and by diversifying your portfolio. It’s also wise to avoid trading with leverage until you have a good feel for commodities investing.
- Know your investing goals. If you’re trying to make money quickly, consider faster-moving investments like day-trading commodities stocks (that is, buying and selling shares on the same day). If you have a much longer timeframe, you can opt to buy and hold a batch of commodity-related investments, whether in an ETF, mutual fund, or other similar vehicles.
- Keep track of overall conditions. For commodities like wheat, orange juice, and other foods, factors like weather can help predict future outcomes. If it’s oil, geopolitical implications come into play. If you have a longer timeframe for investing and want to really know what you’re getting yourself into, getting a handle on macro trends can be a big help.
Try some of our commodities courses for beginners
Still not quite ready to take the plunge? We get it. Start here and learn the fundamentals of commodities investing with our easy-to-follow courses. Once you’ve picked up the ins and outs of commodities trading you’ll be better placed to start making smart investments.