For many people a big attraction of trading with binary options comes from the easy access this trading platform form gives to a wide range of different financial assets. Some of these, in particular commodity binary options, are not easily accessible to retail traders by other means.
While several efforts have been made to introduce these assets into traders portfolios over the years, the fact remains that commodities tend to be one of the least actively traded asset classes by the retail trader. This is largely down to the fact that traders often lack the confidence to deal in them and as a result their workings are not very well understood.
While most retail traders tend to feel confident when investing on Indices, Stocks and more recently even Forex, the commodity markets are more likely to be given a ‘wide berth’. They are often considered volatile and difficult to make money from. However a basic understanding of commodities can provide the trader with an additional market that is well known for throwing up good opportunities to trade.
Types Of Commodities
The broad range of commodity options provided by binary option brokers fall into two key categories; hard and soft. A brief explanation of each is given below:
Soft Commodities – In contracts to being extracted, soft commodities are ‘produced.’ Assets in this class included raw food and material crops such as Wheat, Sugar, Corn and Cotton.
The commonality of both of these groups is that they form the basic raw materials which are used in the manufacture of literally thousands of offer products. Therefore as economies grow and increase their rate of consumption, so too the demand for the commodities which fuel this consumption increases.
A good example here is Oil. As demand for goods increases, so too will the requirement for oil. It is used in manufacturing processes, transportation of raw materials for production and of course ultimately in getting the end product to market.
The large price fluctuations in the commodity prices stem from the level of supply and demand as you would no doubt expect. However with commodities it is not quite this simple as it is not just the level of demand but also the ability to meet his demand which is a key factor in determining price.
The production of commodities is not simply something that can be instantly ramped up to meet demand. It takes a long time to bring new resource pools on stream. This can lead to periods of elevated prices as supply struggles to keep up with demand. Similarly once demand drops, a glut of resources in an economic downturn can quickly see prices tumble.
Commodity Trading Risk
Pricing in the commodity market is broadly dictated by fundamental factors. Price trends on most assets will tend to follow forecasts for economic growth and demand. In terms of soft commodities for example, population growth is often cited as a long term driver of price inflation. The price is assessed as to whether the production of agricultural commodities which will be able to keep up with increasingly global demand.
While long term forecasts are important, the short term ability of the markets to meet the required supply and demand will have the biggest influence on price.
Here are some specific fundamental factors which you can keep a look out for will have an effect on the price of commodity assets.
- Geopolitical factors – War, political tension, trade embargos, trade unions etc
- Regional Government Policy – Here you can think subsidies in terms of Soft Commodities, land planning and approvals
- Weather – Weather conditions can affect the ability to deliver a commodity and also the demand for it i.e. heating in winter
- Trends – Sometimes larger long term trends can pressure pricing. Moves to certain crops for example.
A Final Thought On Commodity Binary Options
One final thing to consider is the role of speculators. Gold is a prime example of a market where speculators have contributed to rapid price gains. Investors piling into an asset or heading for the exit can cause prices to spike quickly – in either direction. Those people trading commodity binary options need to be aware of how quickly prices can move. They will then be able to adjust quickly and exploit the potential for making a profit from them.