How to trade coffee

Coffee trading basics

Coffee is one of the most highly-traded commodities in the world – the market is worth more than $100 billion annually.¹ Here are few useful things to know before you start trading coffee.

Where is coffee grown?

Coffee is grown in more than 50 countries, all with tropical and sub-tropical climates, across what is known as ‘the coffee belt’. The top producers of coffee are Brazil, Vietnam and Colombia.²

Depending on the variety of coffee, it can be grown in higher and lower altitudes. Higher altitude crops are grown closer to the equator, in countries such as Ethiopia and Colombia. While lower altitude crops are grown in areas with specific dry and rainy seasons, such as Mexico and Brazil.

What are the different coffee varieties?

There are two different coffee varieties – Arabica and Robusta. Arabica is considered the premium, more flavourful bean, so it attracts a higher market price. Robusta has a bitter flavour and contains more caffeine. Trend followers like to trade Arabica as it has more stable pricing, while traders who prefer to trade volatility lean towards Robusta.

What moves the price of coffee?

The price of coffee is moved by factors that relate to supply and demand. The factors that impact coffee prices include:

1. The climate: coffee crops are very sensitive to changing weather conditions. If the weather is not conducive to healthy crops – especially if it becomes very cold – coffee supply decreases, and prices will likely rise
2. Distribution costs: transporting coffee requires fuel, which means that the price of oil directly affects coffee prices. The more expensive it is to distribute, the more expensive coffee will become
3. Geopolitics: a shaky political landscape in a coffee-producing country can disrupt supply chains and cause market volatility. This could again lead to higher coffee prices across the globe
4. Global health issues: the ongoing debate surrounding the effects of coffee on health has an impact on its consumption, which in turn leads to heightened or lessened demand
5. Strength of US dollar: as coffee is priced in dollars, any ups and downs in the strength of USD will impact the price of coffee. Additionally, if you’re planning on trading shares of coffee-producing companies, it’s important to learn about the factors that affect share prices

Essentially, if more people want to buy coffee than sell it, the price will rise because it is more sought-after (the ‘demand’ outstrips the ‘supply’). On the other hand, if supply is greater than demand, the price will fall. Coffee prices are notoriously volatile, because any type of interference with production or distribution can have knock-on effects.

Four steps to start trading coffee

Choose a coffee asset to trade

When you trade coffee, it is likely that you will be trading coffee futures. These are contracts in which you agree to exchange a set amount of the underlying commodity at a set price on a set date. These contracts are traded on futures exchanges – it’s important to use the right exchange for the coffee benchmark you’d like to trade.

However, there are some other ways that you can gain exposure to the coffee market. Your choice will depend on whether you want to own the physical assets or not.

For example, you could decide to trade or invest in the shares of coffee-producing companies, such as Kraft or through known retailers such as Starbucks as the shares of these companies are heavily influenced by the price of the commodity but can offer good value compared to trading coffee itself.

Alternatively, you could use coffee exchange traded funds (ETFs), which can be used to trade coffee benchmarks, or track a basket of coffee stocks.

Decide how you want to trade

There are a range of different financial instruments you could use to trade coffee, including futures and CFDs.

Futures are the most popular way of trading coffee, offering high liquidity and volatility. However, futures contracts do have an expectation that the physical commodity will be delivered, unless the contract is rolled over, which can be a problem for some traders.

With CFD trading, you can deal on changing prices of coffee futures and options, without buying or selling the contract. CFD trading uses leverage, which means you only have to put up a small margin to gain exposure to the full value of the trade. This can magnify your potential profit – but also your potential loss. And, as you won’t ever take ownership of the underlying asset, you can go long or short – which means you can speculate on rising as well as falling coffee prices.

Create your risk management strategy

Once you’ve familiarised yourself with the different ways to trade coffee, you can choose which method best suits your trading strategy and risk appetite.

All trading involves risk, especially if you’re trading using leverage, which is why you need a strategy to manage your risk and protect against unnecessary losses. You can minimise your risk by attaching stops and limits to your positions. Stops will close your trade at a certain point if the market moves against you, while limits allow you to set a level to close your position and realise your profits.

Open and monitor your first trade

Once you’ve completed these steps, it’s time to enter the market. When you trade coffee with CFDs, you can speculate on both rising and falling markets. If you think the price will rise, you would open a position to ‘buy’ coffee, and if you think the price will decline, you open a position to ‘sell’. Your trading decision should be based on your analysis of the market and your trading strategy.

After you have opened your position – attaching the appropriate stops and limits – it is important to monitor your position’s progress and to keep up to date with anything that could impact the price of coffee.

To learn more about analysing the market, visit IG Academy

Coffee trading strategies

Coffee trading strategies will depend on your personal preferences and knowledge of technical indicators. Broadly speaking, your trading strategy could take advantage of trending markets, consolidating markets or volatility.

Trading trending markets

If a coffee market is reaching higher highs and higher lows, or lower highs and lower lows, it means that the market is trending. Traders seeking to match their strategy to a trending coffee market will often use indicators such as moving averages to identify buy and sell signals.

Trading consolidating markets

Consolidating markets are markets that remain within support and resistance levels. Traders will use historical levels of support and resistance to identify points of entry and exit within the price range. This coffee trading strategy would involve buying coffee at a known support level and selling when it reaches a point of resistance, taking advantage of shorter-term market movements.

Trading volatility

The coffee market is notoriously volatile due to its complexity and the wide range of factors that affect the price of coffee, such as unpredictable weather patterns.

Trading coffee market volatility can be challenging, but there are technical indicators that can help you. For example, when coffee price action tightens, the Bollinger Band indicator would contract to highlight a fall in market volatility. However, this could also be a pending sign of a sharp rise in volatility will occur. Many traders wait for a sharp breakout of the Bollinger Band, which demonstrates a strong directional move.

What are coffee trading hours?

_{*Hours are set by ICE and may vary. Hours will shift between March and November as the UK and US change to and from daylight savings on different days, while Singapore remains on Singapore Standard Time (UTC+8) all year round.}

¹ Global Edge, 2018
² Coffee Maker, 2019