Finance Definitions: Commodity

Finance Definitions: Commodity

Let’s take a little break from intense stock definitions to focus on the simplicity of a good ol’ finance definition: the commodity. Although this term is used in stocks as well as in general finance, it’s really an easy term that can be used to further your education on both stocks and finance. So let’s jump right in!

What is a Commodity?

Basically, a commodity is a good or service for which people and businesses will shell out cash. This umbrella definition means that almost everything is a commodity, from your car to your husband’s offer to do the laundry; so for the finance and stock world, the definition is narrowed down a little (although I think the laundry-commodity is priceless!).

The narrower business scope takes this “goods and services” definition a little further and states that a commodity is most often used to produce other things. In addition, each commodity is type-set and graded: each should be interchangeable with similar commodities so that we may compare them on the market, and each should have a quality scale on which the commodity can be graded.

Examples Please!

Sure, defining commodity is all good and well, but it still isn’t crystal-clear without examples of commodities. Here are a few common commodities on the stock market: gold, silver, grains, eggs, beef, oil, natural gas, foreign currencies, bandwidth and cell phone minutes.

As you can see in the majority of these examples, these types of goods can be used to produce other items, are interchangeable with other producers, and are graded. But let’s look a little further with an example: eggs. These are a commodity because they can be used to produce baked goods; one farmer’s eggs are very similar to another’s; and they are graded so it’s easier to compare Happy Farm’s Grade A eggs to Sunny Farm’s Grade A eggs.

Why are Commodities Important?

Many businesses base large trades on the price of commodities. If you have a farm background, this is obvious: farmers know what price eggs will catch on any given day based on the farm price of the commodity, so they may wait until a price is favorable to make a large sale. In other businesses, the same thing will happen: businesses will time their sales or purchases until it’s best for their bottom line.

The stock market also varies by the price of commodities. Obviously, stocks that are commodities themselves, like gold, will be impacted by the price. But other stocks may also feel the fluctuations in price. Like in our eggs example, if the price of eggs increases substantially, mass producers of baked goods will also feel the impact and may have to increase the prices of their goods, which will eventually impact the price of their stock.

Commodities have a lot of impact on business practices and on the stock market, so it’s an important term to keep in mind. This basic term may come up often as you continue to learn more about finance and the stock market!

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Alex | Perfecting Parenthood's picture

Alex | Perfecting Parenthood wrote:

Mon, 03/05/2012 - 20:39 Comment #: 1

Hey Christa: Usually in finance when people talk commodity they talk about things that are anonymous or interchangeable. So Gold for example, is just gold no matter where it comes from and you can buy or sell just the gold. You can't really do the same with sweaters because nobody ever wants just a sweater, they want colors, designs, etc that are relatively unique. Commodities can be traded and they have a price, because that is the price at the commodities exchange (which is like a stock exchange). Sweaters don't have a "price" because there is no central market for sweaters and individuals buy sweaters according to individual buyer-seller arrangements at a wide variety of different prices. The exact same sweater could sell to two different people at very different prices.

Christa Palm's picture

Christa Palm wrote:

Mon, 03/05/2012 - 21:11 Comment #: 2

Alex, very true!

MoneyCone's picture

MoneyCone wrote:

Tue, 03/06/2012 - 16:04 Comment #: 3

Futures play a very important role in commodities. Pay attention to futures when you trade in commodities.

Christa Palm's picture

Christa Palm wrote:

Wed, 03/07/2012 - 22:44 Comment #: 4

MoneyCone, great tip -- we'll have to write a whole post about futures at a later date.