In this article, you will get to know about multiple commodity trading strategies which can be used by beginners & traders both to achieve success in Commodity Trading.
Let us know about these Commodity Trading Techniques in detail.
Commodity Trading Strategies & Techniques
While trading in a commodity, using the right strategy is one of the most important things to keep in mind. If you are trading without proper analysis and strategy, it is equivalent to gambling.
In the case of commodities, the price per unit of every commodity is quite high, unlike the equity market. Therefore, it becomes important to preserve your capital by implementing the strategies.
While trading in the commodities market, you can earn profits in many ways, but using the correct strategy will not only help in preserving capital but securing profits too.
Before implementing the strategies, you must be aware of the market conditions and the products being traded.
Apart from this, you must know the basics of technical analysis. Technical analysis is something that you might use in other strategies too.
No matter what market or security you are trading, technical analysis can be used anywhere.
Technical analysis includes analyzing the charts with various indicators to find out the correct entry and exit points for a trade.
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How to use Commodity Trading Strategies in right way?
Let us take an example to understand this. If you are a trader who has been trading in wheat, you will have to do in-depth research about the commodity.
You need to know the impact of various external factors on the demand and supply of wheat. These factors may include government policies, weather, international markets, etc.
Once you get hold of all these factors, you can trade in wheat by applying the correct strategy. After you gain experience in trading wheat, you can add other similar commodities like soy.
The impact of external factors on soy will be the same as on wheat. But if you are trading in wheat and start trading in gold simultaneously, it will become complex.
This is because wheat and gold do not fall in the same segment. Therefore, factors such as weather, government policies, international relations, etc. will have a different impact on both commodities.
To avoid such complexities, you need to choose your niche. As a commodity trader, you need to identify the commodity you wish to trade and also ensure that they fall in the same segment or sector.
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Effective and Successful Commodity Trading Strategies
As a beginner, you can start with any of the following strategies –
Trading based on Fundamental Analysis
While using the fundamental analysis for trading, you must remember the two basic structures of economics that are demand and supply.
In the case of commodities, the fundamental analysis requires you to consider all the external factors that can affect a commodity.
For instance, the price of crude oil dropped by 30% in over a year, in 2020. This happened because of the external factors such as trade war and government policies that lead to a fall in demand. Another example for the same could be a factor such as a season.
A trader might buy a commodity during summers and expect the prices to rise in winters due to excess demand. The fundamental analysis might look like a child’s play to some.
However, it is important to ensure that thorough research needs to be done while implementing fundamental analysis.
This is because different external factors can have different impacts on the same commodity. Therefore, you need to update yourself with the market news as well.
This research requires a lot of time because of which some people do not prefer using fundamental analysis. The implementation of the strategy also requires time.
You might not be able to earn quick profits like in the case of technical analysis, as it requires a lot of patience.
Range Trading – Most used Commodity Trading Strategies
Ranging trading is one of those strategies which can be used not only for commodities but other securities too.
As the name suggests, range trading requires the trader to identify a range. This can be done by analyzing charts and identifying various patterns like Bollinger band etc.
Using this, the trader needs to identify support and resistance levels for security. The basics of range trading suggest buying a security at the support level and selling the same at resistance.
The support and resistance levels of security are directly affected by market demand and supply.
Support and Resistance levels
Price of the security rises when the demand is high. This high demand helps the security in attaining its maximum price, i.e., the resistance.
At this point, all the traders holding the security will sell it off as they fear that price has maxed out, and it might fall from that point.
This leads to a fall in the price as the traders start selling the security, which increases the supply for the same. The price keeps falling and reaches the support level.
At this point, the traders in the market feel that the security is highly undervalued and oversold because of which it might show an upside move. As a result, the traders start buying the security, and the price rises from the support level.
Apart from analyzing the chart to identify support and resistance levels, there are multiple indicators that can be used.
These indicators might be relative strength index, stochastics, momentum, and rate of change, help in analyzing whether a security is overbought or oversold.
Drawbacks of Range trading
However, range trading has some drawbacks as well. Nobody knows the time period for which the security stays in the overbought zone.
In some cases, it might stay at the support level for a long time, which can lead to losses if trading in commodity options.
Also, it is important to note that support and resistance levels are never permanent. In range trading, you must always be cautious before buying or selling at support or resistance level.
This is because there always is a possibility of a breakout that might create new support and resistance levels.
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Breakout Trading – Common Commodity Trading Techniques
In simple words, breakout trading is an alternative to range trading. This is because, in range trading, the trader used to trade at support and resistance levels.
However, in case of a breakout, the trader buys security when it breaks the resistance and sells when the support is broken.
The breakout of support or resistance marks the beginning of a new trend. Therefore, it can be said that breakout trading is done at the beginning of a new trend. In most cases, a breakout increases the volatility in the market.
Therefore by analyzing the breakout correctly, the trader can make profits as the prices of the commodity will move in the direction of the breakout.
However, it is important to note if the price of the security rises just above the resistance level, it is not a clear indication of a breakout.
Example on Breakout Trading
If the resistance for a commodity X is at 500 and the price rises to 501, it does not necessarily mean that resistance is broken. In such cases, the trader must look at the volume in the market.
If the resistance or support is broken with excessive volume, breakout trading can prove to be helpful in earning quick profits.
The extension of this is the trend following strategy. Once a breakout occurs, a new trend emerges. Once the trader has identified a newly emerged trend, he or she might follow the trend for trading.
In the commodity, the trends are usually long term. Therefore, if a breakout leads to the formation of a new trend, there are chances that the new trend might continue in the long run.
Scalping – Highly used Commodity Trading Strategy
Scalping is the technique used to book profits as and when possible. In scalping, the trader minimizes the profit per trade while increasing the number of trades.
This technique helps in earning profits from a minor price change in the commodity. Scalping can help in securing the profits whenever possible and making the chances of loss almost negligible.
Using this, traders can improve their accuracy while trading, which can help in gaining confidence. Since scalping is done at minor price changes, the trader is not stuck with one trade for a very long time.
The brief time period for one trade reduces the risk of any adverse event that might affect the market. In addition to this, the frequency of smaller price fluctuations is greater than that of larger price fluctuations.
Due to this, it becomes easy to book profits even if the market is stable and there are no major moves.
Conclusion – Commodity Trading Strategies
The above-mentioned are some of the most common strategies which can be used while trading in commodities.
The right implementation of these strategies will help you in not only preserving your capital but also securing your profits.
However, before applying these strategies, you must keep a basic point in mind i.e., limit the number of commodities you trade.
In simple words, you should not keep switching between different commodities on a daily basis; instead prefer trading in a particular commodity or a defined segment.
Most people neglect this point and try trading in multiple commodities. This might help them in making profits in some cases, but at the same time, it becomes difficult to analyze all the commodities at the same time.
This causes distraction, which hampers the research and analysis required for commodity trading.
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