The Difference Between Forex and Commodity Trading
The main differences between Forex and commodity trading is the products traded. Both can be traded as pre-defined contracts via a futures exchange, but commodity contracts cannot be traded via the Forex market.
On the Forex (Foreign exchange), the metals can be traded as a currency pair like gold/US dollar (XAU/USD).
- What are Commodities, and How Do I Trade Them?
- What is Forex, and How Do I Trade Forex?
- Is it Better to Trade Forex or Commodities?
- Are there Differences in Regulation between Forex and Commodities?
- How does Leverage Compare with Forex and Commodities?
- Exchange Limits
- Recap of the Difference Between Forex and Commodity Trading
What are Commodities, and How Do I Trade Them?
Trading commodities has a far-reaching history, going back way before investing in stocks and shares.
Commodities prices shift according to supply and demand.
For instance, livestock and meat are a commodity heavily affected by supply and demand.
In 2001, the UK had an outbreak of foot and mouth disease. 2000 farms were affected, resulting in the slaughter of 6 million cattle and sheep. The estimated cost to the UK economy was 8 billion. Horse racing is a lucrative UK industry, but the foot and mouth outbreak saw all races cancelled, and the government banned the transportation of livestock, and even rare breeds were not exempt from slaughter.
Had you invested in livestock or meat before the outbreak, your investment would have sunk into nothing.
Investors often use Commodities as a way of diversifying their investments. Commodity prices tend to move in opposition to stocks, so some investors turn to commodities when the stock markets are volatile.
In days gone by, an investor needed significant funding, time and expertise to trade commodities. Commodities back then were limited to professional traders. But, these days, there are more options for investors looking to get into the commodity markets.
Commodities are known for being a risky investment, primarily because their market depends on supply and demand, which can be affected by global uncertainties like disasters, unusual weather (Hurricanes etc.), pandemics, epidemics or anything out of the ordinary.
Commodities traded typically fall into four categories:
- Metals – precious metals such as gold, silver, platinum and copper are the metal commodities. Notably, gold is a popular commodity for investors because it is considered a dependable metal with real value. Precious metals are often bought as a hedge when inflation is high, or a currency has devaluated.
- Energy – crude oil and heating oil, natural gas and gasoline are the energy commodities. Reduced outputs (diminishing supply) from established global oil wells historically lead to price rises, especially if demand is high.
When the world went into the first Covid-19 lockdown in March 2020, oil prices plummeted. In the UK, for instance, pump prices dropped, and heating oil was as low as 18p per litre. In previous years, heating oil prices had been as high as 68p per litre.
- Livestock & Meat – cattle, pigs, sheep – all animals classed as livestock
- Agriculture – corn, wheat, cocoa, coffee, soybeans, cotton and sugar are all classed as agricultural commodities. Grains can be a volatile commodity, depending on weather fluctuations.
Investors look for opportunities to weigh up population growth (demand) against the available supply of agricultural commodities.
Investors choose to invest in commodities in several ways:
- Futures - A futures contract is a legal agreement to buy or sell a particular commodity or asset at a predetermined price at a specified time in the future. The buyer is obligated to buy or sell once the contract expires
- Contracts - A stock options contract gives the holder the right to buy or sell shares of stocks at a particular price in the future, and they can lock into the market price of the stock today
- Options - An option is a contract that gives the buyer the right, but not the obligation, to buy or sell the underlying asset at a specific price on or before a certain date. Investors sometimes use options to hedge risks
- Exchange-traded funds (ETFs) – an ETF is a group of securities or shares sold on the exchange that combine the features and benefits of stocks, bonds or mutual funds. They are traded through the day at prices according to current supply and demand
As you can see from the above information, trading commodities can be complex because, without experience, it can be tough to know where to put your money. It takes a lot of research for a commodity before you commit to buying it.
What is Forex, and How Do I Trade Forex?
Forex is an acronym for Foreign Exchange.
It is a highly liquid market, trading over $6.6 trillion per trading day.
The idea is you are trading on two currencies, such as GBP/JPY (Great British pound/Japanese Yen). The leading currency (GBP) is the base currency and the second currency (JPY) is the quote currency.
The principles are you decide if you think the pound sterling will rise or the Japanese Yen will fall. If the price drops, it means the Yen is stronger. So, you either buy or sell the pair, factoring in technical analysis and/or fundamental analysis.
Whilst it sounds simple, trading Forex is still challenging. There are fewer components and restrictions than trading commodities, but there is still a lot to learn before becoming a successful Forex trader.
One bonus of trading Forex is that you can open a demo account with a broker to practice how to trade Forex before you start trading with real money.
Is it Better to Trade Forex or Commodities?
Whether you trade Forex or Commodities is purely a personal choice.
Some traders feel that Forex is complex, and it's easier to understand a commodity like, say, gold, livestock, or grains. It is easier to connect to a commodity because you can touch it, eat it, use it etc., but that doesn't mean you can be successful trading it.
Trading Forex or commodities still takes an investment of time, education and money. Both are high risk, and each has a high learning curve for the newbie trader.
When choosing between trading Forex or commodities, bear in mind the following factors:
1. How much money do you have to allot to trading?
only trade with money you can afford to lose. You can open a Forex broker account with a few hundred dollars, but for trading commodities, you would need more capital
2. Your appetite for risk
Both Forex and Commodities trading are risky, but Forex is easier to manage trades if they go pear-shaped
3. How much time do you have to trade?
For Forex and commodities, it is necessary to do your homework. For commodities trading, you may research supply and demand and look at the economy and population growth for the country concerned.
For Forex, you decide which currency pair to trade and then do your analysis on both currencies. The technical analysis measures what is happening on the chart, and the fundamental analysis shows you what is happening economically in both countries.
All of this analysis takes time and dedication. Cutting corners results in losses. If you can dedicate a few hours a day to do your research and wait for a good entry point for your trade, you have a chance of success – and this applies to Forex and commodities
4. What are your goals?
Do you want to have a little fun playing with trading, or are you genuinely determined to work towards becoming a professional trader, drawing an income from your trading?
5. What is your personality type?
All trading takes patience and discipline. If you are naturally impatient, you may struggle to maintain consistent profits and get into trades that end up losing you money.
Before you consider trading Forex or commodities, take a long hard look at your personality type. Are you prepared to do the research needed for trading? Are you happy to wait for a good entry, or are you naturally impulsive?
As you can see from the foot and mouth outbreak example above, you must do your research and weigh up the pro's and cons, looking at every angle of a potential purchase for Forex or a commodity before you hit the buy button
Check Out: How To Find Your Forex Trading Style
Are there Differences in Regulation between Forex and Commodities?
Yes, there are several differences in regulation between forex and commodities trading.
Forex has little regulation. Anyone can sign up with a Forex broker, deposit their hard-earned money, open a chart and enter a trade. Commodities, however, are strictly regulated by Governing Financial bodies, and some traders feel safer with the strict guidelines of financial legislation.
How does Leverage Compare with Forex and Commodities?
Leverage is widely available in the Forex market. Any budding trader can deposit funds into a broker who will offer leverage options without checking into the trader's financial history.
With Commodity trading, leverage is available, but it isn't so easy to get, and it isn't as significant as the levels of leverage Forex brokers offer new traders.
Foreign exchanges are traded via brokers, whereas commodities trade on an exchange. On the exchange, commodities have daily limits. If you exceed the limits, you cannot place additional trades. If you get on the wrong side of a trade, you are powerless to do anything about it and could, realistically, watch as your account dissipates.
That is not a good position to be in and one to be avoided at all costs.
Losses can happen just as quickly in Forex, but the main difference is, you have control over your trades and can close down open trades instantly.
However, if you over-leverage your Forex account, your broker has the right to close open trades to avoid going into negative loss on your account. They will send you a margin call, inviting you to add funds, close trades, or both.
Recap of the Difference Between Forex and Commodity Trading
There are various options for novice and experienced traders alike who want to invest in financial instruments. The levels of complexity for both Forex and commodities are different but, realistically, neither is easy.
Commodities can be volatile when responding to supply and demand. Some currency pairs are equally volatile and reactive to economic news. But some currency pairs are more stable for the novice trader.
The Forex market is highly liquid, which creates multiple opportunities for trading. Commodities liquidity can be less available if supply or demand are out of balance. Market liquidity is an essential factor for all trading. If liquidity is low, your order may not be fulfilled or may only be partially filled.
Whether you trade Forex or commodities, ALWAYS seek a market with good liquidity.
Please note that the above information is not providing advice on tax, investment, or financial services. We provide the above information without consideration for risk tolerance and a specific investor's financial circumstances.
Trading or investing in financial instruments such as Forex and Commodities may not be suitable for all investors. It does involve risk and the possibility of a loss of capital.
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