With more people becoming interested in investing in the markets than ever before, you may have found yourself recently wondering whether there’s an opportunity to make money in the trading of commodities and equities. There’s certainly no shortage of cash to be made, with investors regularly hitting gold – literally.
If you’re new to the markets, then the mechanisms for trading – and even the terminology itself – can seem baffling. But finding your way around the basics of commodities and trading is easier than you may think. Use the guide below as a crash course to help you make the best decision on where to put your funds to see a healthy return.
But before we get started…
What are Commodities and Equities?
A commodity is a product that is commonly used by many people in their everyday lives around the world. Examples of commodities are oil, cotton, and foodstuffs, such as wheat or rice.
An equity, on the other hand, represents part ownership of a company – businesses often use the sale of equities to raise capital.
What About Gold?
Gold is a commodity, and therefore can be traded via Futures and Options contracts, or purchased physically if you would prefer to make a direct investment – in other words, buy something you can actually hold in your hands.
If you’d prefer to invest in gold as a physical product, then you’ll need to spend some time researching the best place to buy gold, and keep an eye on the fluctuating cost of this precious metal (by weight) to spot the optimum time to buy and sell your stockpile.
To invest in gold as a commodity in the relevant markets, then you’ll need to take out a Futures or Options contract – effectively in which you are betting on the value of gold at a certain point of time in the future. Commodities reflect supply and demand; so if the demand for gold goes up, the price of gold Futures and Options contracts will increase, too.
A commodity is not a physical holding but represents a contract taken for a particular length of time on a basic or undifferentiated product. So for example, a commodity could be traded at the future price of gold or wheat. After a certain period, these trading positions expire and have – and can generate – no value.
So, if you are looking to invest in a commodity, you won’t be looking for the best place to buy gold and trade it as a physical entity – instead, you will be speculating on the future price of gold by trading on a contract to this effect. Other examples of commodities that can be traded are cotton and sugar – and there are even weather contracts available for trading!
Equities, on the other hand, represent an investment (or some other form of capital) that is made into a firm or listed entity that relates to ownership or a share in the profits. Equity investments tend to be used by those seeking a long-term investment. Unlike commodities, there are no contracts when it comes to equity trading – as long as the company remains listed on the stock market, the investor can continue to hold the equity for as long as he or she wishes to.
How are Commodities and Equities Traded?
Commodities are traded on the commodities market, mainly in the form of futures and options contracts. Contracts refer to the predicted price of an undifferentiated product and expire after a certain duration of time. Commodity trading is often used as a hedging tool for limiting potential losses or as a way to make a quick profit.
Equities, on the other hand, are traded through stock exchanges and are mainly invested in as a long-term proposition – often as a way to gain ownership of a firm, for example, or to earn a share of future profits. They are regularly taken out for investment in up-and-coming listed firms.
While commodities can be a good way to make a quick profit or limit potential losses, equity trading is regarded as a much more stable proposition. This is largely because trades taking place on the commodities markets tend to be in huge lots, whereas with equity trading, positions can be taken on a single share, thereby limiting risk exposure.
While the commodities market is known for its volatility and propensity for significant – and frequent – price fluctuations, the equity market is concerned with longer-term investments and sees much less seismic shifting, making it a preferable option for many investors.
Other Key Differences
While commodities contracts have no connection to ownership, an equity holder has a stake, or level of ownership, in the firm in which the investment has been made. This means that equity holders have a right to receive dividends from the company; equity shares also tend to have greater liquidity compared to commodities holdings.
In the commodities markets, the price of one instrument has nothing to do with another, which can mean that an investor’s risk is diversified; in the equities market, however, the price of one instrument directly correlates with another. Further, the equity market is a free market, meaning there are much fewer regulations in place than are present in the commodities markets, which, as it concerns derivatives, is overseen by the organization SEBI.
Finally, the commodities markets require a high margin, which varies depending on the type of instrument being invested in. Equity instruments, however, only need to be bought at the current market price.
Should I Invest in Commodities or Equities?
If you’re new to investing in the markets, then equities are almost certainly the better place to start. As well as making for a more stable investment, this will allow you to get a feel for the markets, and for investing in general, and build up a respectable portfolio without incurring too much risk. Once you’ve gained some experience and confidence, you may wish to branch out into commodities trading.
The answer to the question will largely be determined by the type of investor you are and your personal circumstances. Investing in either market will always carry with it inherent risk – but if your risk appetite is high, you’re knowledgeable regarding the commodity you’re considering trading in, and you have experience in the markets, then there’s a chance that investing in these instruments could deliver substantial financial rewards.