Although commonplace amongst the majority of financial traders, there are some stark differences between stock and commodities, and this includes two different types of strategies.
However, the most prominent difference is the securities in which you’re trading. In simple terms, stock trading is the buying and selling of shares in a company, whereas trading commodities are based on physical goods, such as wheat, gold, and oil.
This means that the way in which you trade these varying financial instruments, and the factors that can affect their value, are also very different. Both can be a beneficial addition to your portfolio, but let us explain further about the approach to investing in these different types of assets.
The exchanges
When it comes to commodities, the most common form of trading takes place on future exchanges, involving futures contracts. According to the trading platform Plus500:
“A futures contract is a contract which requires the contract holder to Buy or Sell a commodity at a fixed price at a future delivery date.”
This form of trading is most common amongst farmers, producers, agricultural businesses and other industries that require the raw materials for manufacturing. Basing the trade on a future contract can help to plan the budget and expenses, as well as hedge against any possible losses. For example, if a farmer predicts that the price of a certain crop will drop before the commodity is distributed, then a futures contract can set the price in place and mitigate future losses.
Other investors entering the commodities market base their trading decisions on the speculation of these future contracts, and whether their value will increase or decrease in relation to the worth of the goods. This can also include trading in financial derivatives, such as contracts for difference (CFDs), where you do not actually own the underlying commodity, and trade on the predicted price fluctuations.
The major exchanges for trading commodities are:
- Chicago Board of Trade (CBOT)
- Intercontinental Exchange (ICE)
- New York Mercantile Exchange (NYMEX)
Although you can also trade stocks through CFDs, this security is mainly traded through a stock exchange, over the counter (OTC), or by utilizing a stockbroker to execute the trade on your behalf. The largest stock exchanges are:
- New York Stock Exchange (NYSE)
- NASDAQ Stock Exchange
- London Stock Exchange (LSE)
Stock exchanges monitor the supply and demand of the stocks for each corporation involved in their list, from which the value of the stock is derived.
When trading in either of these financial assets, it’s important to consider the closing times of the relevant markets, as this can differ between the different securities, as well as exchanges.
Trading volume, volatility, and liquidity
For commodities, the volatility and liquidity can range between each of the individual goods. When a certain commodity has a high trading volume, such as crude oil, with significant levels of supply and demand, then the relevant market would be very liquid.
However, commodities with lower liquidity and have a lower trading volume, such as feeder cattle, will experience some sharp price swings. Liquidity is important when trading commodities, as they are traded on futures, and this can affect the level of slippage. This is the difference between the quoted price and the actual price that the trade is executed, and can work for and against your favor.
On the other hand, stocks witness a consistently high volume of trade, making the market noticeably liquid. As a result of this, and several other factors, the stock market can be quite volatile, with prices fluctuating from day today. This makes the market particularly attractive to day traders.
The impacts on price
There are some factors that affect both the stock and commodities market, going on to drive up the value of the financial assets. For example, the relevant national interest rates can impact the storage of goods as well as the cost of borrowing for businesses, and therefore are relative for both stocks and commodities.
However, the main influential factors vary between the two markets. In their simplest form, commodities are affected mostly by supply and demand, and any changes in this balance can affect their value. This is mostly impacted by ‘external factors, such as natural disasters or political events.
In contrast, stocks are mostly affected by what are deemed ‘internal’ factors, which means their value is driven by the financial position and performance of the relevant businesses, such as through earnings and dividends.
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As with any investment, be it stocks or commodities, extensive research into the relevant market and influential factors, are a vital part of formulating an effective trading strategy.
