Liquid Commodities are widely traded at huge volumes by investors, hedgers, speculators/traders and arbitrageurs both in cash and derivative markets. Crude Oil, Natural Gas, Gold, Wheat, Corn and Copper are among the leading commodities that are traded globally at huge volumes. The Deutsche Bank Liquidity Commodity Index(DBLCI) tracks the performance of six commodities in the energy (WTI crude oil and heating oil), precious metals (gold), industrial metals (aluminum) and grain sectors (corn, wheat). Generally, the commodities are classified as energy, metal, bullion and agro.
- Energy Commodities: Crude oil, natural gas and heating oil are the leading energy commodities. Crude oil is the world's most actively traded commodity, and is the underlying commodity for the world's largest-volume futures contract - NYMEX Division light, sweet oil futures contract. Being a key source of the world's energy, crude oil is in high demand by stakeholders. Crude oil is primarily traded by exploration and production companies, oil refining and marketing players, airlines, companies engaged in petrochemicals and others.
- Metal Commodities: Copper is widely used as a raw material for industrial machinery such as the manufacturing of electronic goods, power generation and transmission equipment, telecom cables etc. It is also widely traded.
- Agro Commodities: For a long time, agro commodities trading was synonymous was commodities trading. It was only after the industrial revolution and oil discoveries that this all changed. Even now, though, wheat and corn are still widely traded at high volume.
- Bullion: Gold is also among the leading commodities and is traded at high volume. It is considered as one of the finest conventional investment asset classes as well as an inflation hedge.
Why Liquid Commodities are Suitable for Day Traders
Large trading volumes of the aforementioned commodities ensure lower-impact cost, price transparency and lower trading cost. Loosely speaking, traders can easily find their trading counterparts without jeopardizing their required price range. On the other hand, traders of illiquid commodities would be unable to lock their required price immediately, and more often than not would not even get their trade executed due to poor liquidity and the concomitant opportunity costs.
Trading Techniques of Liquid Commodities
- Spot Market: Investor, trader, end user or any other participant can buy and store the above mentioned commodities. However, theft and damage, as well as carrying costs are associated with holding the commodities in physical form.
- Forward Contract: Since the spot market trade would require the buyer to invest the entire amount to buy the underlying commodity, forward contracts are increasingly used to buy the same amount of exposure without initial investment. Two parties can enter in to a contract to buy the underlying commodity at a pre-decided price and at a pre-decided date. The trade might be settled in cash without giving delivery to the buyer. However, party at profit is exposed to the counterparty risk, given there is no initial margin required to enter into trade.
- Futures: Unlike forward contracts, with futures two parties enter into a contract through an exchange that guarantees the performance and necessitates an initial margin and MTM to carry the contract.
- Options: Options enable the commodity buyers to secure themselves by paying a premium which gives them the right but not the obligation to exercise the contract.
The Bottom Line
Traders, throughout the world use forward contract, future and or/and option contract, and prefer liquid commodities such as Crude Oil, Natural Gas, Copper over illiquid ones to trade given its low execution cost, price transparency and higher probability of contract execution and performance due to large number of participants with huge volumes.