Commodities are physical goods that traders can buy and sell via an exchange, including energies like oil, metals like gold and silver, agricultural goods and soft|metals like gold, silver and copper, energies like oil and gas, agricultural goods, like cotton and grains, and soft, which includes goods like coffee, sugar and cocoa.
Most traders trade commodities with derivatives, which are contracts like futures, swaps, CFDs and options, that represent a certain amount of a certain commodity concerned.
A CFD, or contract for difference, is a contract that enables a trader to profit on the price fluctuations of various commodities. The contract states that the trader must exchange the difference in price between the time the contract is opened, and the time at which it is closed.
So, if gold was trading at was $1,600 an ounce and you thought it would increase, you could open a long CFD position on gold. You buy a CFD, which represents 100 ounces of gold, and the price climbs to $1,625. Your gross profit is USD25 an ounce, or $2,500 in total (excluding any trading spreads, interest and other fees).
There are a number of benefits to trading gold through a derivative like a CFD or option, rather than purchasing it outright. The first is that holding the metal itself necessitates security and storage, and may be difficult to sell when you want.
Another benefit is that derivatives allow you to use leverage. Leverage (or gearing) is essentially borrowing to increase the size or your position in the market and, consequently, magnify your potential returns relative to your initial investment.
Therefore, if your CFD provider offers 20:1 leverage, you could open a position twenty times larger than if you had bought outright.
For instance, if you invested $5,000 in oil and the price of oil rose by 3 per cent, your resulting profit would be USD50. On the other hand, had you an oil CFD on a 5 per cent margin, you could have opened a $100,000 position for the same $5000 deposit. When the price of oil rose by the same 3 per cent, your gross return would be $3,000, a 60 per cent return on your initial investment of $5,000.
Please keep in mind, that as CFDs are geared, they exaggerate losses to the same degree as your profits. As a result, some traders may suffer losses greater than their original investment.