2. Essential Commodity Terminology

1. Arbitrage

Arbitrage is the practice of exploiting price differences across markets or instruments to earn risk-free (or close to risk-free) profit.

For example you could buy physical gold in Dubai and sell gold futures in New York. And you could profit from the price gap after accounting for transport and costs.

In commodities, arbitrage helps keep the spot and futures markets aligned. Traders perform time arbitrage (across expiries), geographic arbitrage (across locations), and even cross-commodity arbitrage (e.g., crack or crush spreads).

Arbitrageurs are the quiet stabilizers of the market. Whenever prices drift too far apart, they pull them back together.

2. Backwardation

Backwardation is the opposite of contango. It happens when the futures price is lower than the current spot price. This usually signals tight supply or strong near-term demand.

For example, if crude oil trades at $80 today but next-month futures are at $75, the market is in backwardation. It often reflects immediate scarcity: refineries need oil now, not later.

Backwardation creates what traders love: positive roll yield. When you roll a futures position from a cheaper future month into a higher spot price, you can benefit from the price convergence.

It's generally seen as a sign of supply stress, urgency, or short-term market tightness.

3. Basis

Basis is the difference between the spot price of a commodity (its current market price) and the futures price for that same commodity (the agreed-upon price for future delivery). It's calculated as: Spot Price - Futures Price.

For example, if crude oil sells today at $70 per barrel, and the futures contract for next month is $73, the basis is -$3. The number itself might seem small, but it gives insight into market conditions like transportation costs, storage availability, and local supply or demand issues.

A narrowing basis means the spot and futures prices are getting closer together - typically as the delivery date approaches. A widening basis means they're drifting apart, which could suggest rising storage costs, shifting demand, or disruptions in the supply chain.

4. Bear Market

A bear market is when commodity prices are consistently falling or expected to fall. It's driven by negative sentiment, oversupply, weakening demand, or broader economic downturns. Traders and investors typically adopt a cautious or defensive stance in a bear market.

For example, if global wheat production surges while demand remains flat, prices might decline steadily over months - that's a bear market in wheat. It doesn't mean prices crash overnight, but that the general direction is downward.

In this environment, producers may cut output, and speculators might take short positions to profit from the decline.

5. Bull Market

A bull market is the opposite of a bear market. It's when commodity prices are rising steadily or expected to rise. It's usually fueled by strong demand, limited supply, inflation fears, or positive economic indicators.

For example, if copper prices rise due to increasing demand from electric vehicle production and limited mining output, that would create a bull market in copper. Traders in a bull market are typically optimistic and look for opportunities to go long.

Bull markets can attract heavy speculation and increased volume, but they can also lead to bubbles if prices become detached from fundamentals.

6. Cash Settlement

Cash settlement is when a futures contract is settled by paying the difference in price rather than delivering the actual commodity. It's common in contracts where physical delivery would be impractical or unnecessary.

For example, if you hold a futures contract for natural gas at $3.50 and the final price on expiry is $3.70, you receive $0.20 per unit in cash. No gas tanks required.

Cash settlement makes trading more accessible and efficient, especially for financial institutions or speculators who are only interested in price movement - not physical goods.

7. Clearinghouse

A clearinghouse is the behind-the-scenes operator that makes sure all trades go through correctly. It acts as the middleman between buyers and sellers in the commodity futures market, guaranteeing each side fulfills their end of the deal.

If you buy a futures contract for gold, you don't have to worry whether the seller will actually pay up - the clearinghouse handles that. It reduces the risk of default and maintains the stability of the entire system.

It also handles margin requirements, daily settlement, and keeps the market running smoothly even when volatility increases.

8. Contango

Contango is when the futures price of a commodity is higher than its current spot price. In other words, it costs more to buy the commodity for future delivery than it does to buy it today.

For example, if crude oil is $70 per barrel now, but the three-month futures price is $75, the market is in contango. This often happens when there are storage costs, insurance expenses, or expectations of rising demand.

Contango affects traders who roll over contracts, since they may end up buying higher-priced futures repeatedly, which can reduce profits over time. It's a normal market condition, but it has important cost implications for anyone holding positions over the long term.

9. Contract Size

Contract size refers to the specific quantity of a commodity covered by a single futures contract. It's standardized by the exchange to make trading uniform.

For example, one corn futures contract on the CME represents 5,000 bushels. If you buy one contract, you're exposed to the price movement of exactly that amount.

Understanding contract size is critical for risk management, since it defines your financial exposure per trade.

10. Crack Spread

A crack spread measures the price difference between crude oil and the petroleum products refined from it - mainly gasoline and diesel. It represents a refiner's gross margin.

For example, if crude oil costs $80 per barrel, and the combined value of gasoline and diesel produced from that barrel is $95, the crack spread is $15. A wider crack spread means refiners are more profitable; a narrower one means margins are getting squeezed.

Traders use crack spreads to hedge refinery margins or speculate on changes in fuel demand versus crude supply.

11. Crush Spread

A crush spread applies to soybeans. It measures the price difference between raw soybeans and the two products they’re processed into - soybean meal and soybean oil.

For example, if soybeans cost $12 per bushel, and the combined value of the meal and oil extracted from that bushel is $14, the crush spread is $2. A healthy crush spread means processors (called "crushers") make better margins.

Traders and producers use crush spreads to hedge processing risk and to bet on shifts in feed demand (meal) or edible oil demand (soybean oil).

12. Currency Risk

Currency risk is the danger that fluctuations in exchange rates will affect the value of a commodity position. Commodities are usually priced in US dollars, so traders using other currencies may see gains or losses unrelated to the actual commodity price.

For example, if a European trader holds a gold position priced in dollars and the dollar strengthens against the euro, the value of their investment changes - even if gold's price stays flat.

Currency risk becomes more important for international investors or when dealing with globally traded commodities.

13. Delivery

Delivery refers to the actual transfer of the physical commodity when a futures contract reaches expiration. While many traders close their positions before this point, some contracts do require delivery of the underlying goods.

For example, if you hold a futures contract for wheat through to expiration and don't close it, you might end up legally responsible for receiving a truckload of wheat. Not ideal unless you're in the grain business.

Most participants avoid delivery by settling earlier, but delivery-based contracts help tie futures prices to real-world supply and demand.

14. Derivatives

Derivatives are financial contracts whose value comes from something else - in this case, a commodity. Futures, options, and swaps are all examples of derivatives.

For example, a crude oil futures contract is a derivative because its price depends on the price of crude oil. You're not buying the oil itself - you're trading a contract linked to its price.

Derivatives are used to hedge risk or speculate on price changes without handling the actual commodity.

Futures are standardized contracts to buy or sell a commodity at a fixed price on a future date.

Options are contracts that give the right, but not the obligation, to buy or sell a commodity at a specific price before expiry.

Swaps are private agreements where two parties exchange cash flows based on commodity prices - often used for long-term hedging.

Forwards are customized, over-the-counter agreements to buy or sell a commodity at a set price on a future date, similar to futures but non-standardized.

Contract-for-Difference (CFD) is a derivative where traders exchange the difference between the entry and exit price of a commodity without owning the contract or the physical asset.

15. Diversification

Diversification means spreading your investments across different assets to reduce risk. In commodities, it involves holding positions in different sectors, like energy, agriculture, and metals, rather than betting everything on one.

For example, if you invest in both crude oil and soybeans, a drop in energy prices might be offset by gains in the agricultural sector.

Diversification doesn't eliminate risk, but it helps limit losses when one market moves against you.

16. Exchange-Traded Commodity (ETC)

An Exchange-Traded Commodity (ETC) is a security traded on a stock exchange that tracks the price of a single commodity or a basket of commodities. It's like a commodity-focused version of an ETF.

For example, a gold ETC allows investors to gain exposure to gold prices without storing any physical metal. It's convenient, liquid, and doesn't involve vaults or insurance.

ETCs are popular with retail investors who want a simple way to invest in commodities through standard brokerage accounts.

17. Expiry Date

The expiry date is the final day a futures or options contract is valid. After this date, the contract is either settled or delivered, depending on its terms.

For example, if you hold a soybean futures contract that expires on April 20, that's your last day to trade it or close it before you're stuck with physical settlement or cash settlement.

Knowing expiry dates is crucial - especially if you don't want to accidentally own 5,000 bushels of soybeans next Thursday.

18. Forward Contract

A forward contract is a private agreement to buy or sell a commodity at a specific price on a future date. Unlike futures contracts, forwards are not standardized or traded on an exchange.

For example, a farmer and a grain buyer might agree today on a fixed price for a wheat shipment to be delivered six months from now. They negotiate terms directly without using a centralized market.

Forward contracts offer customization but come with more counterparty risk and less liquidity than futures.

19. Fundamental Analysis

Fundamental analysis in commodities means studying real-world factors that affect supply and demand - like weather, crop reports, mining activity, global trade, and economic data.

For example, a drought in Brazil might reduce the coffee harvest, which could drive up coffee prices. A trader using fundamental analysis would pay close attention to that kind of news.

It's the opposite of technical analysis, which focuses only on price charts and patterns.

20. Geopolitical Risk

Geopolitical risk refers to the impact of political events on commodity prices. Wars, sanctions, regime changes, and trade disputes can all disrupt supply chains or shift demand patterns, often leading to sudden price swings.

For example, if a major oil-producing country faces sanctions, its exports might drop, tightening global supply and pushing oil prices higher. Even rumors of instability can rattle markets.

Commodity traders keep a close eye on global news, because political events often move prices faster than economic reports.

21. Hedging

Hedging is a strategy used to reduce the risk of price fluctuations. Producers and consumers of commodities use futures or options to lock in prices and protect themselves from adverse moves in the market.

For example, a farmer expecting a corn harvest in six months might sell corn futures now to secure today's price. If prices fall later, the loss on the crop is offset by gains in the futures contract.

Hedging isn't about making a profit - it's about reducing uncertainty and stabilizing income or costs.

22. Inflation Hedge

An inflation hedge is an investment that is expected to retain or increase in value during periods of rising prices. Commodities, especially gold and oil, are often used this way because their prices tend to rise when inflation increases.

For example, if inflation causes the cost of living to rise, gold prices may also climb, helping to preserve the purchasing power of investors.

Inflation hedging is one reason commodities are included in diversified portfolios, especially during times of monetary expansion.

23. Leverage

Leverage allows traders to control large commodity positions with a relatively small amount of capital. In futures trading, you put down a margin deposit, a fraction of the total value, to open a position.

For example, a futures contract worth $100,000 might require just $5,000 in margin. That means small price changes can result in large percentage gains or losses.

Leverage increases both potential profits and risks, and without proper risk management, it can wipe out accounts quickly.

24. Limit Order

A limit order is an instruction to buy or sell a contract only at a specific price or better. It gives you control over execution price, but there's no guarantee it will be filled.

For example, if gold is trading at $1,920 per ounce and you want to buy only if it drops to $1,900, you place a buy limit order at $1,900. If the market never reaches that price, nothing happens.

Limit orders are useful in volatile markets where prices move quickly and you want precision without chasing the market.

25. Liquidity

Liquidity measures how easily a commodity contract can be bought or sold without significantly affecting its price. High liquidity means lots of buyers and sellers, tight bid-ask spreads, and smooth trade execution.

For example, crude oil futures are highly liquid. You can enter and exit positions quickly at near-market prices. On the other hand, an obscure commodity like orange juice may have fewer participants and wider spreads, making trades slower and riskier.

Traders prefer liquid markets because they allow flexibility and reduce the cost of getting in or out of a position.

26. Long Position

A long position is when a trader buys a commodity or futures contract expecting the price to rise. It's the classic "buy low, sell high" play.

For example, if you believe natural gas prices will go up, you go long on a natural gas futures contract. If the price rises, you profit by selling it later at the higher price.

Long positions are often taken during bull markets or in response to expected supply shortages.

27. Lot Size

Lot size refers to the standardized quantity of a commodity in a single futures contract. Each exchange defines the lot size to ensure consistency in trading.

For example, one gold futures contract on the COMEX represents 100 troy ounces. You're not just buying "some gold", you're buying exactly one contract worth 100 ounces.

Understanding lot size is essential because it determines your exposure to price movements and how much capital you need to trade.

28. Margin

Margin is the amount of money a trader must deposit to open and maintain a futures position. It's not a down payment - it's a good-faith deposit to cover potential losses.

For example, a futures contract might be worth $50,000, but you only need $3,000 in margin to trade it. The rest is effectively borrowed, which makes gains and losses much more volatile.

Margins are adjusted daily based on market movements. If your position loses value, you may get a margin call and need to add more funds to keep the trade open.

29. Market Order

A market order is a request to buy or sell a contract immediately at the best available price. It guarantees execution, but not the exact price, which can vary in fast-moving markets.

For example, if you place a market order to buy silver futures, the trade goes through right away at the current ask price even if it's a few cents higher than you expected.

Market orders are useful when speed is more important than price precision, but they can backfire in low-liquidity markets with wide spreads.

30. Mark-to-Market

Mark-to-market is the daily adjustment of a futures position to reflect current market prices. Gains and losses are calculated and either credited or debited to the trader's account at the end of each trading day.

For example, if you hold a wheat futures contract and prices go up $0.50 per bushel, your account is credited based on that move. If prices fall, your account takes a hit.

It keeps the system fair and transparent, but it also means you can lose money even if your long-term outlook is correct, all because of short-term price swings.

31. Open Interest

Open interest is the total number of active futures contracts that haven't been closed or settled. It's a measure of market activity and can indicate the strength or weakness of a price trend.

For example, if open interest in crude oil futures is rising while prices are going up, it might signal strong buying interest. If it's falling while prices rise, the rally could be losing momentum.

High open interest with rising volume tends to confirm trends. Declining open interest often suggests that participants are exiting the market.

32. Physical Delivery

Physical delivery means the actual transfer of the commodity when a futures contract expires. Instead of cash settlement, someone receives barrels of oil, bushels of wheat, or ounces of gold.

For example, if you hold a contract for delivery and don't close it out before expiration, you could end up with a real-world shipment. Most traders close or roll over positions to avoid this.

Physical delivery is essential for certain markets because it keeps futures prices connected to actual supply and demand.

33. Price Limit

A price limit is the maximum amount a commodity futures price is allowed to move in one day, set by the exchange to prevent extreme volatility. Once the limit is reached, trading may be halted or restricted.

For example, if the daily price limit for soybeans is $0.70 per bushel, the price can't rise or fall more than that in a single session.

Price limits are safety mechanisms, but they can also lock traders out of the market when big news hits and everyone is trying to get in or out at once.

34. Risk Management

Risk management is the set of practices used to control potential losses in trading. It includes techniques like setting stop-loss orders, position sizing, using hedges, and diversifying exposure.

For example, a trader might limit their risk on any single trade to 2% of their account balance. Or a company might hedge fuel costs with futures contracts to protect against price spikes.

Without risk management, trading turns into gambling and in commodities, the stakes are rarely small.

35. Seasonal Trends

Seasonal trends are recurring patterns in commodity prices based on the time of year. These are often driven by planting and harvest cycles, weather patterns, or seasonal demand.

For example, natural gas demand often rises in winter due to heating needs, and grain prices may fall after harvest when supply increases.

Understanding seasonal behavior helps traders anticipate movements and avoid surprises that aren't really surprises at all.

36. Settlement

Settlement is how a futures contract is concluded when it expires - either by cash payment or by physical delivery of the underlying commodity.

For example, a cash-settled futures contract will credit or debit your account based on the final price. A physically settled contract requires someone to deliver or receive the goods.

Most traders don't wait for settlement. They close or roll over their positions ahead of expiration to avoid logistics or large cash transfers.

37. Short Position

A short position is when a trader sells a futures contract expecting the price to fall. The goal is to buy it back later at a lower price and profit from the difference.

For example, if you sell gold futures at $1,950 and later buy them back at $1,920, you make $30 per ounce in profit (ignoring fees and stress).

Shorting can be profitable, but it also carries unlimited risk if prices rise instead of falling.

38. Speculation

Speculation involves taking a position in the commodity market purely to profit from price changes, without any intent to use or produce the commodity.

For example, a trader might buy crude oil futures expecting a price increase due to an upcoming OPEC meeting. They don't want oil - just the profit from price movement.

Speculators increase market liquidity, but they also add volatility. They're the gamblers, risk-takers, and sometimes scapegoats of the market.

39. Spot Price

The spot price is the current price at which a commodity can be bought or sold for immediate delivery. It's the real-world price, not a future guess.

For example, if gold is trading at $1,950 per ounce on the spot market, that's what you'd pay right now to take delivery.

Spot prices are the benchmark against which futures prices are compared, and they reflect current supply and demand dynamics.

40. Storage Costs

Storage costs are the expenses involved in holding a physical commodity over time. This includes warehousing, insurance, handling, and security. For bulky or perishable items, these costs can be significant.

For example, storing barrels of oil requires tanks, monitoring, and safety measures - none of which are free. These costs influence futures prices, often contributing to contango when longer-term contracts are priced higher to reflect the expense of holding inventory.

Traders factor in storage costs when deciding whether to sell now or later, especially in physical delivery markets.

Cost of carry is the total expense of holding a physical commodity over time. It includes storage, insurance, financing costs, and sometimes transportation.

For example, if you store crude oil in tanks for 3 months, you pay rent, insurance, and interest on the capital tied up in that inventory. These costs accumulate and futures prices often reflect them.

In normal conditions:
Higher cost of carry → futures priced higher than spot → contango

If the benefit of holding physical goods outweighs these costs, backwardation can happen. Cost of carry is one of the backbone concepts behind how the entire futures curve forms.

41. Technical Analysis

Technical analysis involves studying charts, price patterns, volume, and historical data to predict future market movements. It ignores the fundamental supply and demand story and focuses purely on how prices behave.

For example, a trader might look for a "head and shoulders" pattern on a wheat futures chart to anticipate a potential price reversal, regardless of crop forecasts.

It's widely used in commodity markets, especially for short-term trading, but works best when combined with other tools.

42. Tick Size

Tick size is the smallest possible price movement in a commodity futures contract. It's set by the exchange and varies between markets.

For example, if the tick size for crude oil is $0.01 per barrel and one contract covers 1,000 barrels, then each tick is worth $10. That means even small price movements can add up quickly.

Knowing the tick size helps traders calculate risk, profit potential, and minimum movement sensitivity.

43. Volatility

Volatility measures how much a commodity's price moves over a certain period. High volatility means large and frequent price swings. Low volatility means prices stay relatively stable.

For example, natural gas prices often experience high volatility due to weather-related demand shifts. Gold, while volatile at times, tends to have more stable price behavior over long periods.

Volatility affects risk, margin requirements, and potential profit.

44. Volume

Volume is the total number of contracts traded in a given time period. High volume means a lot of activity and usually more liquidity. Low volume can signal a quiet or thinly traded market.

For example, if 50,000 soybean contracts are traded in a day, that's considered high volume. If only 500 contracts change hands, it may be harder to enter or exit trades without affecting the price.

Volume is often used to confirm price trends. Rising prices with rising volume suggest strength. Falling volume may signal weakening interest.

45. Warehouse Receipt

A warehouse receipt is an official document that proves ownership of a physical commodity stored in an approved warehouse. It's like a title deed for goods.

For example, if you store wheat at an exchange-approved facility, the warehouse issues a receipt showing the exact quantity, grade, and quality. This receipt can be sold, pledged as collateral, or delivered against a futures contract.

Warehouse receipts make physical settlement possible without anyone touching the commodity. They act as proof that the goods exist, meet the required standards, and are ready for delivery when needed.

Start your commodity investing journey with the free Commodities Investing 101 course by Rohas Nagpal.