Coffee Trading: 4 points to consider before trading coffee

With over 2.25 billion cups of coffee consumed worldwide on a daily basis, coffee is actually the second most traded commodity in the world, falling a little short behind crude oil — and one of the oldest as well. Coffee is perhaps one of the most interesting, yet volatile commodities to trade.

Coffee is a member of the soft commodities group along with other items grown by farmers, including cocoa, sugar, orange juice and fruit. Most of these commodities, including coffee, are prone to wild changes in price, and traders must consider a variety of factors about coffee production and demand when making decisions regarding coffee futures.

The coffee bean type is an important factor to consider when trading coffee. There are two main types of coffee: Robusta and Arabica. The Robusta coffee beans trade at higher prices, in large part due to the demand from large, global customers including Nestlé, Kraft, Procter & Gamble and Sara Lee.

These companies together buy almost 50% of all the coffee produced worldwide, and they are also known as the “Big 4” coffee roasters.

By following these massive companies’ movements is where we have to start paying attention. Because the volume of coffee these enterprises purchase, any changes in their demand can affect the prices of coffee futures.

The Arabica coffee bean may be considered higher quality by the industry, and we are likely drinking Arabica bean coffee when we buy Starbucks or other premium coffees.

It’s important to understand that the fundamentals of Robusta can affect Arabica price because Robusta is a very close substitute.

Most coffee traders will focus on Brazil when trading coffee because Arabica beans are predominately grown in Brazil. Being Colombia the second largest producer.

1 ) Weather Conditions

Coffee grows on small trees, so the crops stay in the ground all year. Being more sensitive to any weather change. The trees must flower each spring to produce a good crop.

The history shows that most of the biggest moves in coffee prices happen because the trees get damaged by cold weather. Showing that the prices can move very quickly and jump higher than many expect if a freeze hits the growing region of Brazil or other main producers.

2) Political Instability

More than 65% of the world’s coffee beans production come from five countries: Brazil, Vietnam, Colombia, Indonesia and Honduras ( crop year 2017–18) If any of those countries experience political instability, this could strongly affect the coffee production, scarcity and then, prices.

3) Consumers Demand

Europe is the largest consumer of coffee, drinking more per capita than the rest of the world. The U.S. is also a significant consumer. Developing countries like China and some South American countries continue to become more accustomed to coffee and may have a huge increase in demand in the coming decades.

4) Supply and Demand Elasticity

First, it’s important to understand the behavior of the supply and demand of coffee and the causes of the price volatility.And the first one is what we called the “adverse supply”. It means the supply will be strongly affected because of different conditions such as weather effect, political stability, etc. We can say that if the demand of coffee is inelastic (when people buy the same amount whether the price drops or rises) when the supply shifts there will be a significant increase in price.

If there is an increasing in the market demand this can also cause a big impact in the price especially if the elasticity of the supply product is low (when the quantity producers are willing to produce does not change as the price increases or decreases).

In the coffee market and other commodity markets, it’s very hard for the market to supply extra products causing strong pressure on the price level.

Final thoughts and tips

So, the extreme price variance makes coffee dangerous to trade on a short-term basis unless you can be monitoring the markets throughout the day. Successful trading also requires to be disciplined, manage your risk and get out of the market quickly if the trade doesn’t work.

Some traders prefer trading coffee over a longer-term strategy. That means looking for bigger moves in coffee over a matter of weeks.

The following chart shows the change in price of the last 6 months (By October 2019). Here we can appreciate better the high price volatility:

You can also trade coffee by selling options instead of using futures contracts. Coffee options typically have a large amount of premium in them because of the market’s penchant for wide price changes.

For example, you can sell a put option, instead of purchasing a futures contract. Selling options carry a good deal of risk, similar to a futures contract.

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