The Importance of Understanding the Commodities Market

In this educational post, I'll be explaining the reason why both investors and traders need to understand the commodities market.
The commodities market is a market in which raw, hard, and soft commodities are traded.
Examples of commodity assets include gold, oil, wheat, grain, copper, and even livestock.
While these aren't commonly traded markets among retail investors, understanding assets within the realm of commodities can provide an edge in trading and investing.

Benefits to Investors
- The primary reason that investors needs to understand the commodity market is because it helps provide an overall picture of the entire financial market.
- For instance, in the case of Nickel, Copper, Zinc, and other industrial metals, the price action differs depending on the market cycle, and certain metals are sensitive to, and heavily affected by specific industries.
- Popular commodities like Gold and Oil’s price action reflects the overall market trend and sentiment.
- As such, a retail investor with a deep understanding in commodities is capable of looking at the stock market from a different angle.

- Secondly, understanding commodities provides a huge advantage in terms of portfolio management.
- How 'well' you have invested, isn't simply determined by your annual return.
- Your sharpe ratio (your return divided by the volatility) tells a more accurate story.
- In order to succeed as a retail investor, you need to focus on increasing your sharpe ratio, or your risk adjusted return.
- And the best way to do so, is to diversify, specifically by looking at the correlation between certain assets.
- There are a plethora of assets in the commodities market that provide a great hedge / means of diversification against the stock market.
- Leveraging this knowledge will help investors design a portfolio that provides them great risk-adjusted-returns.

Benefits to Traders
- The commodities market can be a great opportunity for traders, as long as they spend their time getting used to the market.
- Normally, when the stock market is overbought, or when it demonstrates sideways action, traders often make the mistake of overtrading.
- Traders enter positions at suboptimal levels, because they have no option but to trade at the stock market.
- However, understanding the commodity market gives them an edge. The best analogy to explain this, is like playing online poker.
- When playing poker, the player waits for good hands to appear, so he can make a bet in his favor.
- When he plays online poker, he can have multiple games going on at once, and play the game where he gets the upper hand.
- In the same vein, when a trader knows how to trade commodities, instead of waiting for a good entry in the stock market, he can simply trade assets within the commodities market.
- If you think stocks are overvalued, there’s a chance for you to move onto gold, silver, oil, or even industrial metals.
- You can take a look at multiple assets, and find one that has a good risk/reward ratio right now.

Conclusion
The commodity market is a market that is huge in size, yet often overlooked my many, if not most retail traders and investors. However, understanding which assets are traded, their price action (in relation to other assets), can help both investors and traders acquire an edge.