A Quick Look at the Language of Commodity Trading
What Is Commodity Trading?
The buying and selling of commodities (like vegetable oil, grains, and metals) for a profit.
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Commodity trading or really any type of trading comes with its own language; no one outside the field understands what on earth you are talking about. Truthfully, that language plus the ability to build relationships with customers are all you need to be a commodity trader. Throw in some fundamental mathematics and you’ll go from broke to a millionaire within a relatively short amount of time—well, a shorter amount of time than by flipping burgers. Here’s a quick look at some of the terms you’ll need in your arsenal to be an effective trader.
Commodity Trading Terms
Current and Future. It sounds straightforward, and it is. "Current" means what something is worth if you were to sell it at a price today, while selling a "future" means you are selling a good before it is harvested, crushed, refined, etc…
Basis. All a basis does in commodities is compare the current price to a future price. Now there are different factors that go into basis, and depending on what market you want to work in you should learn those, but fundamentally a weakening basis means sellers will probably want to trade futures rather than current.
Basis Point is a measure of how much a goods value moves in a period (usually from the open). It is different depending on the market, but in the US, it is normally equal to a change of .01%. So, if something changes 100 basis points down it means the price fell 1%.
Inverse. Trading at an inverse means that the future months price is less than the month before it. This happens in commodities around harvest time.
Carry. Trading at a carry is the exact opposite of an inverse. It means the month is trading higher than the former month. This happens, for example, when a harvest has ended.
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Parity. A parity is how a trader prices something. They will look at a market or good and price that good on a different market or on a different good, sometimes both. So that you can conceptualize this I’ll give you an example.
Example: There are two goods available in Dar es Salaam (Tanzania), good A and good C which are substitutable. There is not enough of good C to supply the entire marketplace. Good A is imported from America at $10 and being sold at 130 in local currency. Good C is produced locally in Tanzania can be sold for 100 at local currency. Selling at an import parity means that the producers of good C sell their product at 130 local currency. They would do this rather than sell under the market because since they don't produce enough to supply the whole market, they should be able to sell off their entire stock.
Spot and Forward. Both terms have to do with currency; fixing currency is an important part of trading. Trading "spot" means you are trading currency at today’s value, while trading "forward" means you are trading currency at a future date. This means you are aren’t buying currency until a future date when you are paid for a good after it is delivered. FWD points are added onto the spot which give you a forward rate. In this case a forward point is 1/1000 of a dollar. An example below.
Example: The bank offers to sell you $13,100 dollars at £1: $1.31 spot. This means you are buying dollars and selling pounds at that exchange rate, so you’ll spend £10,000. Say you want to buy dollars forwarded to one month later; the bank agrees and says okay your FWD points are 15. What this means is that you’ll still be buying your $13,100 but your rate will be £1.0015: $1.31, meaning you’ll spend £10,015. Effectively what’s happening is the bank is saying that the pound will get weaker against the dollar over time, giving you an exchange rate of ~£1: $1.3080.
These are all the terms I could think of as the necessities. If you think of any yourself, please feel free to comment and I’ll do my best to get back to you with an explanation.
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Did these examples make sense?
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
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© 2018 Brandon Yudkoff