CFDs are complex financial instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money. CFDs are complex financial instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Choosing a market for CFD trading

Lesson 5 of 6

Trading CFDs on commodities

CFDs are generally a more accessible way for individuals to deal on commodities when compared to traditional trading - mainly because of the mechanics of dealing and the way the markets are priced.

The mechanics of dealing

In the underlying market, commodities are usually traded in large sizes called contracts. Gold is traded in sizes of 100 troy ounces, for example, while Brent crude oil is dealt in 1000 barrel contracts, which is the equivalent of 42,000 gallons.

Realistically, these sizes are too large for many individuals to trade. If gold was priced at $1000 per troy ounce, one lot would cost $100,000. Similarly, if Brent crude cost $50 per barrel, one lot would be worth $50,000. Although leverage is generally available for commodities futures, you'll normally be asked for a margin payment of at least 5-10%, increasing in volatile market conditions.

Commodity CFDs mimic buying commodity contracts in the underlying market. But instead of buying or selling the physical asset, when you trade CFDs you are exchanging the difference between the opening and closing contract prices. Commodity CFDs also benefit from leverage, meaning you only need to pay a relatively small deposit compared to the full size of your position.

How commodities are priced

Commodities are priced very differently in the underlying market compared to shares, indices or forex. Shares are all priced in the local currency where they're listed, indices are measured in points and forex rates have a standardised notation.

Now consider the commodity prices in the table below. Each one is measured in a different unit, most tend to be priced in dollars - however there are a few exceptions.

Market Example price
Brent crude oil $45.85 per barrel
Natural gas $2.265 per mmBtu
Gold $1072.55 per troy ounce
Cocoa (London) £1713.00 per tonne
Lumber $250.00 per 1000 board feet

However, as we’ve seen, when you trade CFDs on these markets you don’t buy the commodity outright, but instead trade on movements in its price. That means you don’t need to pay as much attention to the units and the currency as you would when trading in the underlying market – though you do still need to make sure you know exactly how much one contract is worth for each commodity.

For example:

Market Value of one contract (per full point)
Brent crude oil $10
Natural gas $10
Gold $100
Cocoa (London) £10
Lumber $1.10

Spreads on commodities

Just like shares, commodities futures are traded on specific exchanges around the world – which means there are official buy and sell prices available in the underlying market. Providers will then add their own spread on top of these as the charge for dealing in that market.

These spreads are often variable, meaning that they tend to fluctuate throughout the trading day based on the market conditions. When advertising their spreads, providers will usually quote one of the following:

  • Minimum spread - the tightest possible spread a provider will offer
  • Typical/standard contract spread - the spread a provider will apply most of the time

Here are the standard contract spreads IG quotes for the markets we've already looked at:

Market Standard contract spread
Brent crude oil 2.8
Natural gas 3
Gold 0.3
Cocoa (London) 3
Lumber 60

As you can see, these spreads vary dramatically depending on the underlying market, and could also get wider if that market is especially volatile or illiquid.

While it’s always important to check the details of any market carefully before trading on it, this is especially true of commodities. Due to the different ways commodities are priced and the size of spread they can be subject to, what ‘one point’ means can vary significantly from market to market.

Question

Which of these commodities would you expect to carry the higher risk from sudden and erratic market movements?
  • a Gold
  • b Lumber

Correct

Incorrect

The higher spread (80 points) gives the clue. Lumber is an uncertain industry, vulnerable to a variety of factors including construction downturns, production and manufacturing troubles and varying consumer need. This means its price is likely to fluctuate much more frequently than, say, gold, which (as a general rule) tends to remain in constant demand. When you bet on markets with wider spreads, such as lumber, bear in mind that the market will have to move much further in your favour before you can begin to profit.
Reveal answer

Impact of leverage

When you trade commodity CFDs, you’ll need to put up a margin payment which may only be a small proportion of the value of the raw material you’re dealing on. Remember that your potential loss could be much greater than this, however.

Lesson summary

  • Commodities are usually traded in large sizes called ‘contracts’
  • With commodity CFDs, each contract you trade is worth a certain amount of money per point movement in the underlying market
  • Commodities are often priced in different units and different currencies
  • Like shares, there are official buy and sell prices for commodities available in the underlying market, which providers then wrap their own spreads around
  • The spreads fluctuate throughout the day based on market conditions, and could get wider if the market is particularly volatile or illiquid
  • When you trade commodities with CFDs, you could lose or gain more than you initially put down due to leverage
Lesson complete