8 Great Advantages of Commodity Trading over the Stock Market

Compared to the good old stock market, commodities trading is a completely different kettle of fish. While the general trading basics – remaining emotion-free, studying price charts to spot patterns, combining technical and fundamental analyses – apply both to commodities and stocks, there are some unique properties to the commodities market that provide distinct opportunities. In this article, we detail eight key advantages of trading commodities over trading stocks. For stock traders, this is food for thought. For seasoned commodity traders, these advantages put your trading activity in perspective.

Advantage 1 – Higher volatility that creates great returns opportunities. Commodities, at least some groups of them, are known for significant volatility. While this volatility creates a potential risk of losses, it also means higher returns potential. The great rule of trading – the higher the risk, the higher the potential reward – applies to any market where financial assets are traded, and commodities are certainly no exception. While the stock market has plenty of volatile stocks and segments, the overall volatility of the commodities market is a notch or two higher. The only major commodities segment that is regarded as low-risk is precious metals, particularly gold. Even this asset is known to produce some serious short-term volatility, though it is largely a low-risk investment from a long-term perspective.

Advantage 2 – Better leverage opportunities. The major financial product used in the commodities market is futures. Futures trading in commodities opens up opportunities to use significant leverage multiples. While futures are not unique to commodities and exist for stocks as well, their use in the commodities market is much more widespread. On average, stock market trading comes with considerably fewer leverage options than commodities trading.

Advantage 3 – Lower fees for active traders. Commodity futures are a highly liquid and active market. The fees for trading the futures are often lower than the fees associated with trading stocks. This might be particularly relevant for traders whose strategy involves placing frequent or numerous trades.

Advantage 4 – Diversification potential. Many investors, particularly among the retail investor folk, maintain portfolios that are very “stock-heavy”. Their portfolios have an overabundance of stocks, often to the detriment of wider diversification. By investing in commodities, these traders can better diversify their overall investment.

Advantage 5 – Variety of segments to invest in. The commodities market is not a monolithic environment. There are several major commodity segments, each with their own specifics and different risk levels. Commodity traders who prefer to diversify into different segments can choose from this variety when composing their portfolios. Different commodity segments may even be used to hedge risks and create risk-balanced portfolios. For example, energy or agricultural commodities might make up the higher-risk portion of your portfolio, while precious metals can be used to hedge the risks and lower the overall risk profile of your investment.

Advantage 6 – No short sale restriction. Since 2010, the stock market has been subject to the so-called Short Sale Restriction (SSR). The restriction says that traders cannot short a declining stock that has lost over 10% from the previous session’s closing price. For some traders, the presence of this restriction adds an undesirable limitation to their trading strategies. The good news is that no such restriction is applicable to the commodities market.

Advantage 7 – Better opportunities in trend trading. Although in general the commodities market is very volatile, a unique feature noted by many seasoned traders is its conduciveness to following a trend. When some commodities set on an uptrend or downtrend, they often continue along the trend for a longer period than is typically observed in the stock market. This opens unique opportunities to profit from trend following techniques. Of course, in order to take advantage of commodity trends, you first need to get intimately familiar with the specific commodity segment. Each segment, be it metals, agricultural products, or energy commodities, has its own unique patterns and trend dynamics. In fact, this dynamics is often specific down to the level of a particular asset.

Advantage 8 – Opportunities to profit from seasonal patterns. Commodities, especially the agricultural segments, are known for their established seasonal patterns. Traders who specialize in these commodities are in a unique position to profit from the seasonal patterns. The stock market does have its own (limited) seasonal opportunities but these are tiny compared to what is available to you in the commodities market.

In conclusion, we should note that although commodities present the great advantages and profit opportunities described above, it is imperative that you specialize in one or a few commodity segments to gain the necessary knowledge for leveraging these opportunities. Don’t forget that the commodity market is actually a combination of several distinct markets, each with its own unique risk profile, seasonality patterns, and price dynamics.