How To Understand the Basics of the Commodity Market

You can learn about commodity markets and other financial markets by taking online finance classes. Commodity markets are marketplaces where primary or raw products are swapped. These raw products or commodities are traded on regulated merchandise exchanges, in which they are sold and bought in contracts that are standardized.

The basics of commodity market may be traced from a transaction among Midwest farmers in Chicago in the mid 1800s. These farmers met to sell their crops to interested buyers. As they became accustomed to this trading, they sold their crops even before they were actually harvested. Then there were commitments to future exchanges of crops against future payments. Thus, the "commodities futures market" developed.

A farmer would contract with a buyer to deliver a certain quantity of his harvests at a price they both agreed to. The time of delivery was also agreed upon. This agreement is now known as "futures contract." Both the buyer and the seller knew their obligations: the buyer knew how much he would pay, and the seller knew the quantity of harvests he would deliver. Accordingly, the "commodities market" was born.

The contracts became frequent and documents were used on their behalf. Documents started to be exchanged. Farmers used the contract as collateral for a loan. The buyer could sell the contract if he decides not to take the commodity. If the farmer seller also decides not to deliver his harvests, other willing farmers would take the obligation. As the condition in the agricultural market dictates, the price of the commodity goes up and down.

Wheat was the raw commodity during those times. In bad weather the wheat contract was valuable to the seller because supply was less. But during abundant harvest the contract was less valuable. After some time, assumptions and suppositions came into the picture. Investors began betting whether the price would be high or low. From this background, countless merchandise started to be traded. Today, each of these products has commodities futures markets: wheat, soybeans, oils, corn and other vegetable oils.

Before the actual release date of the commodity, the contract may transfer from one hand to the other. However, once the delivery becomes due, it is mandatory that the commodity be delivered. In the beginning people feared they would have the commodity dumped in their homes. The actual happening was the difference between the price of the winner and the price of the loser and would be paid by an exchange of money.

Commodities are "real assets." Stocks and bonds are "financial assets." Therefore, commodities change according to changing economic ways that are not the same as the conventional financial assets. As the need for goods and services multiplies, the price of those goods and services rises as well, as do the prices of the products that were used to generate those goods and services. Because prices of products usually rise during inflation, investors must be careful in choosing an investment.

Commodity trading is not limited to soybeans, wheat and corn. The commodity market includes prized metals and other merchandise in addition to agricultural products. But they all started with the 5,000 bushels of wheat traded in Chicago.

Learn more about the history of the different types of financial markets by taking online courses in finance.


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