Commodities trading is a huge sector of the investment industry, with everyone from private individuals right up to institutional investors getting involved in commodities as a means of capitalising on supply and demand. In addition to trading commodities in the physical sense, there are also a raft of other ways in which commodities can be traded indirectly, which provide a work-around for some of the less desirable side effects of trading commodities. With CFDs in particular, the benefits afforded to investors can be significant, and can have a massive impact on your bottom line.
Trading physical commodities has always, and will always, present traders with a number of headaches that just aren’t present when trading commodities with CFDs. While essentially the basis of the transaction is the same in both trading styles, physical commodities have certain barriers to entry that make them a difficult choice for smaller traders.
Take, for example, the burden of physically handling commodities. Whether you’re trading in oil, coffee, wheat or livestock, commodities are expensive things to buy, ship and store. A commodity trader buying 100 barrels of oil might want to think about these additional issues, and indeed the additional costs that come with warehousing and distribution, and for some traders without substantial resources to fund these ancillary costs, trading in physical commodities is simply out of the question.
Contracts for difference on commodities provide an easy way around this dilemma, by taking the physical purchase and making it notional. With a CFD transaction, it is not the commodity that is being bought and sold, but a contract based on the value of the underlying commodity – thus, CFDs are an intangible asset that requires no extra burden beyond financing the transaction.
Similarly, the costs of actually buying a CFD position are comparatively lower than buying a load of any one commodity. Because the contract is priced at a certain level that bears relation to the underlying asset price, traders can often take a position indirectly in a commodities market through CFDs for a much smaller capital outlay, allowing less financially established traders to get in on the action.
Another key difference in trading commodities through CFDs is the ability to leverage the transaction, thanks to the margined nature of CFD trading. Because CFD transactions are, as a rule, much larger than the capital the trader is required to initially stump up, traders can take positions that are comparatively larger than what they can afford upfront, so they can reap the rewards of amplified profits from the same transaction.
At a margin of 5%, for example, traders can up their transaction size by some 20 times, which suddenly makes a one point movement in price much more appealing than that same movement would be for a trader holding physical commodities. For this reason, even traders and funds that could otherwise afford to take a physical position in a market opt instead to take a CFD position, to take advantage of the leverage afforded by contracts for difference.
Trading commodities pound-for-pound and through CFDs have their own distinct advantages and drawbacks, and for most traders, it’s a case of weighing up the pros and cons to decide the best approach to any particular transaction. However, with lower market entry requirements, and the ability to generate much more significant returns from similar movements in price, CFD trading on commodities allows traders the freedom to choose a profitable, if not risky alternative to traditional commodities investing.