Why trade gold and silver?

The precious metals, and particularly gold and silver have been traded since prehistoric times. The reason for their high value is the result of their rarity. They are expensive and difficult to mine, and in demand for their decorative and physical properties, being used for jewellery and decoration, and as a medium of exchange, either by weight or in the forms of coin.

In the modern world they have retained their appeal for jewellery and coinage and have actually increased in importance because of their use in electronic equipment and medical applications.

They are also seen as stores of wealth or safe havens in times of market uncertainty.

There are a number of ways to trade gold and silver.

Physical trade in gold and silver

Unlike other commodities, gold and silver have a high intrinsic value. It is perfectly feasible to trade in bullion or coin. Many investors have some of their holdings made up in this way – although there will inevitably be costs for storage and insurance.

Commodity traders dealing directly in gold and silver aim to buy when the price is low, which is usually determined by an abundance of supply and falling demand. They sell when they believe the supply is outweighed by the demand, which can result in a profit.

However, like other commodities, the price of gold and silver can fall as well as rise, and this approach can be a disadvantage when prices are falling.

As well as physical trading, it is possible to invest in commodity stocks and exchange-traded funds (ETFs). Stocks provide indirect exposure to precious metals through the companies involved in their production and use. Commodity ETFs – such as a gold ETF – will be set up to closely follow the price of that metal in the underlying market.

Again, this approach can be a disadvantage when prices of gold and silver fall.

It is also possible to speculate on the price of gold and silver without physically buying metal through a number of financial derivatives. Using these, it may be possible to profit in a falling gold and silver market, as well as a rising one.

Gold and silver trading with CFDs

CFDs (Contracts for Difference) are a derivative instrument that can be used to trade commodities, and can be used to trade gold and silver, without ever owning the metal in question.

A CFD is a contract between a trader and a broker with a set end date. Traders who expect an upward movement in price will buy the CFD and go long, while those who see the opposite downward movement will open a sell or ‘short’ position. At the end of the contract, the two parties exchange the difference between the price of the metal at the time they entered into the contract, and its price at the end.

So if you opened a long (buy) CFD trade on silver when it was priced at £1,500, and you closed the trade after the price of silver rose to £1,600, you would make a profit on the difference in the price of £100. If the price fell to £1,400, you would make a loss of £100.

In practice, it's important to remember that your trading profit isn't simply the difference between the opening and closing price of the trade - you also need to consider the costs of trading such as the spread.

CFDs can be simpler than other trading vehicles like options and futures. The relative ease of entering and exiting positions has helped make trading commodity CFDs popular, but there are a number of other benefits.

The first is the availability of CFDs. Commodities including gold and silver are traded globally, across exchanges around the world. This means that traders can trade twenty-four hours a day, five days a week.

Being able to trade around the clock allows a dedicated gold and silver trader to keep a very close eye on the factors that influence prices, and to react immediately to any changes that would affect a position.

Perhaps even more important is leverage. Leverage is a key feature of CFD trading, because it allows a larger market exposure for a smaller initial deposit. Leverage works by using a deposit, known as margin, to provide increased exposure to an underlying asset. In other words, it means putting down a fraction of the full value of the trade.

It can be a powerful way to increase exposure and potential profit, but it can also amplify losses.