Commodities vs stocks: Top 5 differences and Trading Tips
Mar 16, 2020
Stocks and commodities are two of the most commonly traded assets in the world today. And they are two very different investments. Stock investment means buying and selling shares in various corporations, while commodity trading involves the buying and selling of publicly traded commodities such as crude oil and precious metals.
In the stock exchange, there is no single market, but several stock markets from different countries. It is also known as the equity market, and shares of registered corporations are traded here.
In these markets, traders buy and sell shares of companies open for public trading. Sellers seek specific prices for their shares, and the buyer can either purchase all or a percentage of those shares. You can buy and resell these shares in just a few days, or on the same day if you want.
Commodity trading is the trading of contracts. There are basically two markets. One is the cash market, and the second is the future market. Traders here also buy and sell, but what they buy and sell depends on either of the markets mentioned above.
In the cash market, actual goods,such as livestock or bushels of grain,are bought and sold. These are real commodities. In the future market, contracts are made to provide a certain amount of product at a specific time in the future.
When people talk about commodity trading, they are not talking about actual goods; they are talking about the selling of future contracts. These contracts are used by farmers and producers as a measure to protect themselves from certain risks. Because no matter who ends up with the deal in the end, they will eventually get the payment they were promised for their respective commodity. Gold, silver, crude oil, petroleum, wheat, rice, soy, corn and live cattle are a few examples of commodities for which you can purchase a futures contract.
The fundamental difference between the stock market and commodity trading is the products they deal with and the process of buying and selling. The stock market deals in shares of a company while commodity trading, be it cash or future, trades either in contracts of a separate shipment or in an actual purchase of the product. That being said, here are the five significant differences in the function of the stock market and commodity trading.
You can own stock, but you can only have a contract in futures. While investing in a stock, the buyer takes ownership of a certain share in a company, which is why stocks are referred to as shares. However, in future commodities, you are not buying or selling the actual product; you are making a contract to be a buyer or seller of that commodity.
By trading the contracts instead of the actual product, you can make money if the prices go up or down. This never happens in stock since stock traders can never sell a stock they don’t own. But this is quite common in future commodities because you don’t have to hold the actual product to sell it since we are talking about the future delivery of that commodity.
You can even enter into a contract to supply a commodity at any price and then try to buy it at an even lower price before the delivery date.
- Time duration
Another big difference in stock and commodity trading is the time difference in which the two remain in exchange. Though you can buy and sell your stock in a day, people who invest in stock rarely do that. Many stocks remain on exchange for many years while their companies continue with their business.
Investing in stock for an extended period and retaining the asset for many years is known as a buy and hold strategy. This is more popular due to the historical trends which have resulted in creating wealth for the investors.
However, commodities are traded in future contracts. In commodity trading, the trader promises to deliver the specific product at a particular time in the future. Though you would never actually take delivery of a contract, it is essential to keep in mind when an agreement expires, since the market for it is reducedthe closer the contract gets to expiration.
- Two-way contracts
Futures always have a buyer and a seller since a contract requires both parties. A deal is made between two parties where one is a buyer and the other is a seller of a commodity.
However, since the delivery is in the future, the seller can then get into another contract with a producer and make a profit by buying that commodity at a lower price and make a profit. Or they could make a contract with the producer first and then look for a buyer. The commodity markets are usually so liquid that you can always easily find someone to make the trade. With just a few exceptions, the fills are almost always prompt.
In the stock market, you can only purchase the stocks available by that particular company. If the company stops issuing more stocks and nobody is willing to share theirs, you cannot do anything about it.
- Location and trading hours
Commodity exchanges are generally located near the production centers. The stock exchange, on the other hand, is only situated in a few big cities. Trading times for the stock exchange vary, but they generally close in the afternoon or evening. On the other hand, commodity markets are open round the clock with a break over the weekend.
- Market knowledge and analysis
Trading in the stock market needs a good understanding of market analysis, fundamental and technical analysis, and the forces driving the prices. Before investing, one needs to study a company and its financial condition in order to fully understand the risk involved in the purchase.
The commodity market requires less knowledge since these commodities are natural resources, and the only important thing a trader needs to keep in mind is to deliver on time.
Tips for stock trading
- Pick companies, not stocks
- Set long-term goals
- Diversify your investments arenas
- Stay up-to-date with the market and expert analysis
- Avoid over activity
- Control emotion.
Tips for commodity trading
- Do not enter commodity trading with stock market ideas
- Avoid overtrade
- Get basic knowledge of the market and understand the trading process
- Diversify investment in different commodities
- Get the service of a broker to gain market insights
- Understand the logistics
Whichever you choose to trade, commodities or stocks, it all comes down to a few fundamental decisions. Are you willing to get in the game for long-term investment or do you want to take advantage of the short-term business found in commodities? And how much risk can you take?
Commodity traders also need to carefully consider some risk management before investment. Though there is risk in both, the stock market is generally considered less risky. Investment in either market has the potential for tremendous results. You just have to decide which one is the best for you and you are good to go.