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Five Trading Tips to Trade Stocks Versus Commodities

 

December 22, 2022 (Investorideas.com Newswire) Both stocks and commodities can be volatile in the markets, thus providing both short-term and long-term trading opportunities. While many traders dabble in both stocks and commodities, there are several differences that you should be aware of to help determine when to trade either. Commodities like oil and gold are commonly traded, and very few require ownership of physical assets. When traders transact equities, they often own the underlying asset. Here are five trading tips that can help you on how to trade stocks versus commodities.

First a Definition

First, it's essential to define what is meant by stocks and what is meant by commodities. When individuals consider stocks, many view them as the stock market or an index such as the Dow Industrial Average or the S&P 500. While stock indices are critical to investors, the term "stocks" here is more accurately applied to the shares of individual companies such as Apple or Amazon.

Commodities are raw materials. They are usually intermediate products but can be final products used by consumers. For example, oil is an intermediate product used to make gasoline. Gasoline is a final product used by consumers.

Commodities can also be viewed as an index. The Refinitiv/CoreCommodity CRB index comprises 19 commodities, such as gold, oil, and wheat, as well as soft commodities, such as cocoa. This article will view stocks as individual stocks, like Apple, and commodities as individual commodities, like gold trading.

Fundamental Analysis

One difference between the way you might evaluate stocks relative to commodities is through fundamental analysis. The term can mean several different concepts. Fundamental analysis can mean studying macro events and deducing how those events could impact the price of stocks or commodities. For example, GDP (Gross Domestic Product) will affect stocks and commodities. More robust economic growth will generally provide a backdrop where companies will outperform, and the oil demand may rise.

Fundamental analysis regarding stocks and commodities can also be very different. Regarding equities, some analysts pore over a company's financial record to determine if the value is expensive or cheap, relative to the current price.

The forward price-to-earnings metric is one of the most common tools used to determine whether a stock is expensive or cheap. The price to earnings of a company tells an investor a ratio of the price of the stock relative to the past earnings that the company has produced. Most companies report their earnings quarterly. To measure the price to earnings (PE) ratio, you could look at the price at any time and divide the stock price by the profits from the prior quarter.

The PE ratio is beneficial, but it is backward-looking. The evaluation is about the earnings that have occurred. An alternative is to look at the forecasted earnings. The forward PE ratio estimates what could happen in the following and future earnings periods. The most common forward earnings period to evaluate is the next 12 months, equal to the next full fiscal year.

Several different metrics can be used to evaluate the health of a company and your ability to determine if the current price reflects the company's value. There is the PEG ratio, which helps normalize the PE ratio. There is a price to book and a price-to-sales. The underlying theme is that the analysis is based on the health of an individual company.

When evaluating commodities, the fundamental analysis is a function of supply and demand. Analysts will evaluate the available oil supply compared to the demand. A product's supply will usually be comprised of domestic production and imports. The demand is generally made up of domestic consumption and exports. The underlying difference between the analysis of stocks and commodities is a company's individual health relative to a commodity's supply and demand.

Trading Style

Many strategies are used when it comes to the trading style that investors use for stocks and commodities. One clear difference is that some companies will pay their investors dividends. A dividend is a portion of the profits a company pays its investors.

Because a company pays dividends, but commodities like oil or gold do not, holding stocks for more extended periods provides an argument for a buy-and-hold strategy. Buy-and-hold is a strategy in which an investor purchases shares of a company looking for capital appreciation and dividend payments. Not only could a stock provide you with upside capital gains, but some stocks could provide investors with income, increasing the overall returns.

Both stocks and commodities can be volatile, which could provide short-term investment opportunities. Commodities, when they are under or over-valued, can be long-term investments, but since they do not produce dividends, the gains are limited to capital appreciation. Many analysts will also use technical analysis, which studies past price movements to trade stocks and commodities.

Owning a Stock and Commodity

Another difference between stocks and commodities is how individuals own these investments. When you purchase a stock, you can have a portion of ownership of the company. This could also include voting rights for who will be on the board of directors and earn a dividend. Commodity ownership is usually different. While traders will transact trades that allow them to purchase and sell commodities, they will unlikely take ownership of these products.

For example, if you purchase crude oil, you might buy a contract for difference (CFD) that tracks the movements of oil prices but does not give you ownership of that oil. If you want to own the physical oil, you would need a place to store it and have a mechanism that ensures the oil did not leak from its tank and that the grade was up to par. Some people will purchase small amounts of gold or silver, but re-selling your precious metals means you need a reputable place to buy them.

When Do Stocks and Commodities Trade?

Most commodities trade around the clock, 24 hours a day. You can find CFD and futures brokers that will provide you with access to commodity trading at all hours. While stock indices are similar, individual stocks are usually only traded on an exchange while the exchange is open. For example, if you want to trade a stock listed on the New York Stock Exchange, you will need to wait until the exchange is open to transact. Some stocks trade after hours, but the liquidity is lighter. The NYSE core hours are 9:30 AM ET to 4:00 PM ET.  

Liquidity and Costs

The cost to purchase a stock or commodity can vary depending on liquidity. Larger stocks such as Apple and Amazon provide strong liquidity, so the spread between the bid and offer is usually very tight. A tighter bid-offer spread benefits the investor, as you pay less each time you make a trade. The bid-offer spread can be much wider when you trade illiquid stocks. Commodities will vary as well. Liquids like oil will have a tighter bid-offer spread than live cattle futures contracts.

The Bottom Line

The upshot is that there are some differences between stocks and commodities and how you might trade them. Commodities are considered raw materials and are used to process finished products. Stocks are ownership in a company. Since you might own part of a company, you can consider holding the shares for long periods looking for capital appreciation and receiving a portion of the profits as dividends. Commodities do not pay dividends, and while you might consider holding a position for an extended period, it may only be to benefit from capital appreciation.

You can use fundamental analysis to evaluate both stocks and commodities. At the same time, both are subject to changes in growth. Fundamental analysis of stocks is usually geared toward the health of a company, while the fundamental analysis of commodities is generally focused on supply and demand.

The ownership of stocks gives you a portion of the company and you may receive a dividend. When you trade a commodity, you usually trade a financial asset that tracks the movements of the commodity instead of owning the commodity directly.

Commodities will trade around the clock, and CFD and futures brokers will provide traders access to trading in many time zones. While some stocks will trade after hours, most stocks will trade during the periods when the exchange they trade on is open. The liquidity of stock prices and commodities can vary. Most liquid stocks have tight bid-offer spreads. Commodities can also vary, but many more have low liquidity available.


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