12 February 2024
Commodities vs stocks: 5 main differences and trading tips
Here is a deeper look at how the commodity market compares to the stock market.
1. Ownership of the asset
When you invest in stocks, you actually get ownership of the asset and a share of the company (unless you trade derivatives). With commodity futures, however, you are not actually buying the underlying commodity, but rather the contract that represents it.
2. Trading duration
Although stocks can be traded for a short period of time, investing in stocks using a buy-and-hold strategy means ideally holding the asset for many years. This is a popular plan because of the historical long-term trends demonstrated by global stock markets that have allowed investors to build wealth. However, commodities are more commonly traded in day trading, swing trading, or even scalping because their price is influenced by fundamental factors that may be more favorable for shorter time frames in volatile markets.
3. Key drivers
Stocks and commodities can be affected by the same fundamental factors. For example, interest rates are relevant to commodities because they affect the cost of holding inventory, while interest rates can also affect stocks through their impact on the cost of borrowing incurred by businesses. However, when a push comes to shove, the main driver of commodities is supply and demand, and the main driver of stocks is the financial performance of the companies involved: earnings and dividends. These are discussed in more detail below.
4. Trading hours
Although the closing times of stock exchanges vary, they usually close in the afternoon/evening. For example, the NYSE trades from 9:30 to 16:00 local time. Commodity markets, on the other hand, operate almost around the clock with a weekend break. For example, gold futures are traded from Sunday to Friday from 18:00 to 17:00 EST.
The spread between bid and ask can vary between assets, and the spread for stocks is usually low due to how easily stocks can change hands. However, despite the availability of large volumes of commodities such as crude oil, the lower liquidity of assets such as orange juice and cattle can mean that the spread is prohibitively high.
Trading commodities or stocks - which is best for you?
Trading commodities versus stocks will come down to some key decisions. Do you want to take advantage of the short-term fluctuations often found in commodities, or are you in it for the long-term equity game? Which fundamental drivers best fit your knowledge base? And what is your attitude to risk? Below, we'll take a look at each of these.
Short-term or long-term trading?
While trading stocks in the short term using technical indicators is a viable approach, if you want to invest in stocks for the long term, a common approach is to purchase the asset itself. This is in the form of shares of a company, often through a brokerage account, that are held for a longer period of time - usually at least five years. Despite significant fluctuations, the S&P 500 index has averaged about 10% annualized returns over the past century.
However, commodities are mostly short-term trades, as there are often more opportunities to benefit from volatility as an active trader than as a long-term investor. Volatility of commodities tends to be the highest among asset classes; for example, quarterly volatility of crude oil has ranged from 12% to 90% since 1983.
What are the main drivers to follow?
As already mentioned, commodities are mainly dependent on supply and demand factors. For example, large-scale infrastructure development can increase the demand for copper, which will lead to an increase in its price. For agricultural products, seasonality can have a strong impact on the market, meaning that the price rises or falls at certain times of the year. Oil prices can be affected by factors such as political events, industrial production growth, and the use of alternative fuels. These types of fundamental factors are important to commodity traders, so knowing how each market reacts to such factors is key.
On the other hand, stock prices are heavily influenced by a company's financial performance and business strategy. What does the balance sheet look like? How has revenue grown? How is the company outperforming its competitors? This is a different set of considerations to take into account than commodities, and accordingly, a different mindset may be required.
What is your risk appetite?
Prospective commodity traders should carefully consider their risk management compared to exchange trading. We have seen that certain assets, such as oil, can be extremely volatile. In addition, since the margin requirement for commodities is significantly lower than for stocks, there is a possibility of significant losses in commodities. Traders should ensure that they have the necessary capital to cover margin requirements. Of course, with greater risk comes greater potential reward, which is why so many people choose to trade certain commodity assets.