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What is Commodity Trading? Comprehensive Guide
The buying and selling of commodities and their derivatives is known as commodity trading. Commodities refer to tangible or physical goods like raw materials, agricultural goods, metals, etc, that we use daily, like grains, cotton, fuel, tea, sugar and metals such as gold, copper, zinc, etc. Commodities are raw materials that are used to prepare a variety of finished goods. Commodities trading refers to the buying and selling of these commodities in an open market.
Published on 08 January 2024
The last decade has witnessed a slight boom in commodity trading in India. The prices of commodities typically move in the opposite direction of stocks. That is why investors often invest in commodities to diversify their portfolios during market volatility. Commodities are traded into four categories: metal, energy, livestock and meat, and agricultural. Like the stock market, commodity trading is also accessible in several ways, through commodities trading group who allow you to trade in futures contracts, options, and exchange-traded funds (ETFs).
To begin trading in commodities, you must choose a commodities trading corporation. They are usually brokers and open a commodity trading account. It is vital to do a thorough research on the commodity market before trading. One should understand the risks involved, set the investment goals, develop a trading strategy and start trading through the MCX exchange. One should closely monitor the market trends and news to make well-informed decisions.
There are three platforms for commodity exchange in India.
- Multi Commodity Exchange (MCX)
- National Commodity and Derivatives Exchange (NCDEX)
- Indian Commodity Exchange (ICEX)
These commodities exchange corporations provide a medium to trade in various commodities. Investors increasingly turn to agricultural commodities trading platform for coherent trading experience.
Categories in Commodity Trading
- Agriculture Products - Palm oil, Sugar, Tea, Grains, Corn, Oats, Rough Rice, Soyabean, Rubber etc
- Metals - Copper, zinc, Lead, Brass, Aluminium, Cobalt, Nickel, Tint, Molybdenum etc
- Precious Metals - Gold, Silver, Palladium, Platinum
- Energy Products - Crude oil, Uranium, Ethanol, Natural Gas, Propane, Heating oil, PTA, etc
- Dairy and Livestock
Commodities markets provide producers and consumers an access to a centralized and liquid marketplace. Speculators, investors, and arbitrageurs hedge future consumption or production using commodity derivatives. One of the major commodity categories that is considered a good hedge fund against inflation is precious metals like gold, silver, platinum, etc. These asset classes can help diversify the portfolio as prices of commodities usually move in opposition to stocks; these assets can help during market volatility.
Factors Affecting the Price of Commodities
Commodity prices depend on the demand and supply of the commodity. When the demand for the commodity increases, this results in an increase in price. Similarly, when the demand for the commodity decreases, the price of the commodity decreases.
On the other hand, if the supply of the commodity increases, the price decreases. Whereas when supply of the commodity decreases, then the price increases. Price of commodities can be affected by government policies, the global economy, geopolitical tensions, climate change, and total production. The agricultural commodities trading platform facilitates direct transactions between farmers and buyers to enhance transparency and traceability.
For example: If there is reduced rainfall in a cotton-growing region, this will affect the supply of cotton and influence the global price of cotton in that year. Similarly, the growing demand for electric vehicles will have an impact on the demand for fuel and result in price reductions.
Types of Order
In India, there are three types of commodity contracts:
Spot Contracts:
In spot contracts, there is an immediate settlement of commodities.
Futures Contract:
In Futures contract, commodities are traded at a standardized future price. The buyer in the futures contract has both an obligation and right to buy the commodity at the predetermined price in future and the seller has to sell that commodity at that price.
Options Contract:
In Options contract, the buyer has the right and not an obligation to buy the commodity at a predetermined price.
Commodity contracts involve delivery at the end of the agreement, which requires delivery in cash settlement. As per the contract, there will be an actual transfer of physical goods at the predetermined price.
Advantages of Commodity Trading
Trading in commodities provide multiple benefits like:
Diversification of portfolio
The returns in commodity markets mitigate the risks associated with capital markets. The returns here are inversely proportional to equity and debt markets. When the price of a commodity increases, it negatively impacts the cost of production of the business. Hence, it affects the overall profitability of the company. Therefore, investing a certain amount in the commodity markets may result in reducing the danger associated with financial markets.
Provides Low margin:
In commodities trading, a trader can access the borrowed capital and increase his exposure to commodities. He can enjoy low margins as compared to stocks and bonds.
Types of Traders in Commodity Investment
Speculators:
Speculators are the people who try to predict if the price of commodities like gold will go up or down.
Hedgers:
Hedgers are the people who use future contracts to safeguard themselves against price fluctuations.
How To Begin Commodity Trading?
To begin your journey in commodities trading, you must follow the steps mentioned below:
- Choose a reputed commodities trading group or a broker who is registered with the major commodity exchanges.
- Open a trading account by providing personal identification, financial information, address proof, and other required documents as specified by your broker.
- Deposit funds into your trading account through various payment methods like bank transfers, online transfers, and checks.
- Conduct detailed research on the commodities that you want to trade after considering factors such as supply, demand, market trends, global events, weather conditions, etc.
