Commodity vs Forex Trading

Commodities and foreign exchange (forex) markets are some of the most popular markets worldwide. While commodities markets involve the trading of metals, agricultural products, and energy, forex markets include the trading of currency pairs. Commodity vs. forex trading is often discussed by traders worldwide since these markets are global in nature and are significantly impacted by macroeconomic factors.

In this blog, we will look at the difference between commodity and forex trading. Additionally, we will explore the important factors of the two markets, such as risks and profitability.

What is Commodity Trading?

To better understand commodity vs. forex trading, it is important to know the details of each market individually.

As the name suggests, commodity trading refers to the trading of various commodities. The commodities market is a global market with over 50 major commodity markets that trade in several commodities.

Like any other marketplace, the commodities market facilitates the buying and selling of commodities. Traders can use commodity derivative contracts like futures and options to place speculative bets or hedge their positions.

Commodity trading can be classified based on the type of commodities traded:

• Metals & bullion: Gold, silver, zinc, copper, etc.
•  Energy: Crude oil and natural gas.
• Agricultural products: Wheat, cotton, sugar, coffee, etc.
• Other products: Rubber, jute, etc.

In India, commodity trading takes place on commodity exchanges. These exchanges are similar to stock exchanges but focus on commodities. The major commodity exchanges in India are:

• Multi Commodity Exchange (MCX)
• National Commodities & Derivatives Exchange (NCDEX)
• Indian Commodity Exchange (ICEX)
• National Multi Commodity Exchange (NMCE)
• ACE Derivatives and Commodities Exchange
• Universal Commodity Exchange Limited

On a global level, some of the biggest commodity exchanges are The Commodity Exchange (COMEX) and New York Mercantile Exchange (NYMEX).

Factors Affecting Commodity Prices

There are various key factors that can impact the prices of commodities. They are - 

Supply & Demand

Supply and demand are the primary moving forces of prices. When the supply of a commodity is more than its demand, it leads to a decline in its price. On the contrary, when the demand is higher than the supply, it leads to an increase in prices.

Inflation

Inflation impacts the economy as a whole. A rise in inflation reduces the purchasing power of money, which in turn leads to an increase in the price of commodities. Government policies such as interest rates hikes can help control inflation and bring down the price of commodities.

Geopolitical Events

In the age of globalisation, events taking place in one part of the world can have an impact across the globe. Geopolitical events like wars or government instabilities may hamper the production, transportation, or trade of commodities, leading to a rise in prices.

Natural Disasters

The production of several commodities is dependent on the weather. Adverse climatic conditions like droughts can disrupt the production of commodities, which in turn can result in a rise in prices. Natural disasters like floods or earthquakes may also damage commodities and increase prices.

What is Forex Trading?

Forex, short for foreign exchange, is the most significant financial market in the world. The forex market facilitates the buying and selling of currencies from various countries. Forex trading, also known as currency trading, sees participation from large banks, financial institutions, and even central banks of countries.

The forex market facilitates the trading of currencies in pairs. When you trade a currency pair, you buy one currency and sell the other. The two currencies are referred to as the base currency and the quote currency. This facilitates the exchange rate for a particular currency.

Currency trading can be done through derivative contracts like futures and options or by directly exchanging the currency. The spot price of a currency refers to the price at which the currency can be exchanged immediately, while the future price signifies the price of the currency at a later date.

Some of the major currency pairs are:

• (EUR/USD)
• (GBP/USD)
• (USD/JPY)

In India, forex is traded mainly on the National Stock Exchange (NSE), Bombay Stock Exchange (BSE), and Metropolitan Stock Exchange of India (MSE). Traders can trade forex through SEBI-registered brokers. Platforms like Tradingview enables traders to analyse price charts, plot trendlines, and make use of indicators.

Factors Impacting Forex Prices

Similar to commodities, several key global factors impact forex prices.

Interest Rates

Interest rates play an important role and have a significant impact on the country’s economy. Higher interest rates tend to increase the value of the domestic currency, while a low interest rate environment can devalue the currency.

Geopolitical Events

Geopolitical events such as wars or political instability may negatively impact several aspects of a country’s economy, leading to a decline in the currency’s value.

Central Bank Policies

Central bank policies also play a vital role in the value of a country’s currency. Policy decisions regarding money supply, inflation control, or open market interventions can impact the value of a currency.

Economic Indicators

Certain economic indicators like GDP growth, inflation, and payroll data play a role in the future of the country’s economic policies. These factors and policies also impact the value of a currency.

Key Differences Between Commodity and Forex Trading

The table below highlights the key differences between commodity and forex trading:

Pros & Cons of Commodity Trading

Pros of Commodity Trading:

• Allows an investor to diversify their portfolio.
•  Certain commodities like gold can act as a hedge against inflation.
• Commodities have intrinsic value as they are backed by a physical commodity.

Cons of Commodity Trading:

• Higher capital requirements compared to forex trading.
• Agricultural commodities are susceptible to risk from climate crises and incur storage costs.
• Limited trading hours.

Pros & Cons of Forex Trading

Pros of Forex Trading:

•  Forex trading is highly liquid allowing traders to easily execute trades.
• Transaction costs are lower compared to commodity trading.
• Forex trading offers scalping opportunities and enables traders to capitalise on short-term price movements.

Cons of Forex Trading:

• Higher leverage increases the risk and possibility of higher losses.
• Global events can have a significant impact on currency prices.
• Forex prices can be highly volatile and require solid risk management. 

Which Market is Better for Traders?

The commodity and forex markets offer plenty of opportunities for traders. Beginners can trade in the forex market since the capital requirement is lower and highly liquid. Traders could also find multiple scalping opportunities in the forex market and benefit from the high leverage.

The commodities market is ideal for someone looking to hedge their positions to secure their physical productions. It is also suitable for long-term investors looking to diversify their portfolios.

How to Start Trading in Commodities and Forex?

• Before beginning to trade in commodities and forex, a trader should understand the difference between commodity trading and forex trading. 
• One should then pick a suitable broker that offers facilities to trade in currencies and commodities. 
• Compare the features and costs of different brokers before picking one.
• Deposit the initial funds
• Select a currency pair you want to trade and make a trading plan
• Make use of platforms like Tradingview to conduct technical analysis and study candlestick charts.
• Any beginner trader should have strong risk-management principles. 
• Avoid overleveraging your positions and keep a strict stop-loss in place.

Final Thoughts

Commodity trading vs. currency trading has its pros and cons. While currency trading allows traders to trade, hedge, and invest in commodities, currency trading enables traders to capitalise on short-term price movements in the forex market.

Commodity trading and currency trading can offer several opportunities to someone looking to venture into newer markets. However, a trader should conduct a thorough analysis and manage risk effectively before trading in either market.