How to trade cocoa

Cocoa trading basics

Cocoa, famously known for producing chocolate, is a highly traded industry. Used by ancient tribes as early as 600AD and exported to Europe from the year 1585, cocoa has a rich and interesting history. It now attracts traders almost as much as chocolate lovers, with the cocoa market reportedly worth more than $2.1 billion.¹ Here are few useful things to know before you start trading cocoa.

Top cocoa-producing countries

The top cocoa producers are West African countries like Cote d’Ivoire (Ivory Coast) and Ghana, as well as Latin American countries like Brazil and Ecuador. West Africa is responsible for the majority of cocoa production, worldwide. The top five cocoa-producing countries are:²

What are the different cocoa varieties?

There are three different cocoa varieties – Criollo, Forastero and Trinitario. Criollo is the rarest variety, accounting for only 5% of global production, while Forastero is the most common type of cocoa, accounting for roughly 80% of production.³ Trinitario is a hybrid cocoa bean, which ranges between average and superior quality. The higher the quality of the bean, the better the taste of the cocoa and the higher the market price.

What moves the price of cocoa?

The price of cocoa is moved by factors that relate to supply and demand. Essentially, if more people want to buy cocoa than sell it, the price will rise because it is more sought-after (the ‘demand’ outstrips the ‘supply’). On the other hand, if supply is greater than demand, the price will fall.

The factors that impact cocoa prices include:

1. The climate
2. Labour issues
3. Geopolitics
4. Global health issues
5. Crop diseases
6. Currency movements

The climate

Like most crops, cocoa plantations are very sensitive to changing weather conditions. They require a warm climate and regular rainfall. Harsh weather conditions can have far-reaching consequences. If the crops can’t produce healthy beans, the cocoa supply will decrease, and prices will likely rise.

Labour issues

Top producers like Ghana and Indonesia often experience political issues related to labour, including wage wars and an underaged workforce. Cocoa production relies heavily on low labour costs; therefore, any new labour regulations can affect the price.

Geopolitics

Political uncertainty, corruption and unrest in cocoa-producing countries can disrupt production and supply chains, causing market volatility. This could again lead to higher cocoa prices across the globe.

Global health issues

For years, chocolate was considered bad for our health. However, more recent studies have proven that the antioxidants in dark chocolate can have a positive impact on our health. Depending on the public view of chocolate, as well as chocolate trends, the demand for cocoa may increase or decrease over the long term.

Crop diseases

Cocoa crops are plagued by various damaging plant diseases. This has a severe impact on the harvest, which leads to reduced output. For example, in 2010, the ‘Black Pod’ disease resulted in the loss of half a million tonnes of cocoa.

Currency movements

Cocoa is typically priced in British pounds and any ups and downs in the strength of GBP will impact the price of cocoa. A weak pound generally means that commodity prices drop, and the demand increases. If the pound strengthens against other currencies, cocoa becomes more expensive and demand decreases.

Additionally, if you’re planning on trading shares of cocoa-producing companies, it’s important to learn about the factors that affect share prices.

Cocoa trading strategies

Cocoa trading strategies depend on the trader’s knowledge of technical indicators, and their personal preference. Generally, traders could employ a range trading strategy, a breakout trading strategy or a fundamental trading strategy.

Range trading strategy

In a range trading strategy, a trader will identify levels of support and resistance in an asset’s price movements and seek to buy at levels of support and sell at levels of resistance. Range strategies work best in markets with lots of price movements, where there is not any particular long-term trend.

Breakout trading strategy

Breakout trading involves trying to spot the early stages of a trend and opening a position during this period. This enables traders to capitalise on profits once the trend moves above a level of resistance or, alternatively, once it breaks below a support level. In the context of cocoa trading, breakout traders will try to make a prediction about global supply for the upcoming year and open a position accordingly.

Fundamental trading strategy

Fundamental trading is a strategy in which traders depend heavily on the factors that affect levels of supply and demand. Fundamental traders will look at company-specific or region-specific events that could affect supply or demand for cocoa at the particular point in time. They will then base a trade on their findings.

Four steps to start trading cocoa

1. Choose a cocoa asset to trade
2. Decide how you want to trade
3. Create your risk management strategy
4. Open and monitor your first trade

Choose a cocoa asset to trade

When you trade cocoa, it is likely that you will be trading futures. Futures are contracts in which you agree to exchange a set amount of the underlying commodity at a set price on a set date. These contracts are traded on futures exchanges. There are other ways that you can gain exposure to the cocoa market. Your choice will depend on whether you want to own the physical assets or not.

For example, shares of cocoa-producing companies are heavily influenced by the price of the commodity. Therefore, you could decide to trade or invest in companies such as Mondelez or known retailers such as Lindt.

Alternatively, you could use cocoa exchange-traded funds (ETFs), which can be used to trade cocoa benchmarks, or track a basket of cocoa stocks.

Decide how you want to trade

There are a range of different financial instruments you could use to trade cocoa, including futures and CFDs.

Futures are the most popular way of trading cocoa, offering high liquidity and volatility. For traders, the disadvantage of trading futures includes an expectation that the physical commodity will be delivered – which they don’t want. Therefore, it’s necessary to ensure rollover arrangements are in place.

With CFD trading, you can deal on changing prices of cocoa futures and options, without buying or selling the contract. CFD trading uses leverage, which means you only have to put up a small margin to gain exposure to the full value of the trade. This can magnify your potential profit – but also your potential loss. And, as you won’t ever take ownership of the underlying asset, you can go long or short – which means you can speculate on rising as well as falling cocoa prices.

Alternatively, you could choose to invest in the shares of cocoa companies or ETFs through our share trading service.

Create your risk management strategy

Once you’ve familiarised yourself with the different ways to trade cocoa, you can choose which method best suits your trading strategy and risk appetite.

All trading involves risk, especially if you’re trading using leverage, which is why you need a risk management strategy to protect against unnecessary losses. There are ways in which you can minimise your risk, which includes attaching stops to your positions. Stops will close your trade at a certain point if the market moves against you, to prevent you losing more than you’re prepared to.

Open and monitor your first trade

Once you’ve completed these steps, it’s time to enter the market. When you trade cocoa with CFDs, you can speculate on both rising and falling markets. If you think the price will rise, you would open a position to ‘buy’ cocoa, and if you think the price will decline, you open a position to ‘sell’. Your trading decision should be based on your analysis of the market and your trading strategy.

After you have opened your position – attaching the appropriate stops and limits – it is important to monitor your position’s progress and to keep up to date with anything that could impact the price of cocoa.

To learn more about analysing the market, visit IG Academy.

Cocoa trading hours

^{*Hours are set by Intercontinental Exchange (ICE) and may vary. Hours will shift between March and November as the UK and US change to and from daylight savings on different days, while Singapore remains on Singapore Standard Time (UTC+8) all year round.}

Cocoa trading in summary

• The cocoa market is reportedly worth more than $2.1 billion
• The top cocoa producers are West African and Latin American countries
• The price of cocoa is moved by factors such as the climate, labour issues and geopolitics
• The cocoa market offers the opportunity to make a profit on both rising and falling prices
• Cocoa trading strategies include range trading, breakout trading and fundamental trading strategies
• Cocoa trading hours are set by ICE and vary per region

Sources

¹ Markets and Markets, 2019
² World Resources Institute, 2015
³ Barry Callebaut, 2019