Commodity Trading – Benefits, How to Trade, Reasons to Trade & more
Last Updated Date: Nov 16, 2022In this article, you will come across all the aspects of commodity trading. Here is a detailed guides, which will help you get started with commodity trading.
Know about types of Commodities, Price Discovery Process, How to Trade in Commodities, Why Invest in Commodities & various other important aspect.
What is a Commodity?
Commodities are physical assets that have importance in everyday life, including metals, energy, or agricultural products.
These are movable goods whose ownership can be transferred easily. This means that these goods are exchangeable and tradeable.
Actionable claims and money do not fall in the purview of commodities.
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Commodity Trading in India
Commodity trading started way back in time when compared to stock and bonds. The ancient empires existed because of the commodity trades.
However, modern-day commodity trading is a lot different than in ancient times. Now not only the global institutions but also retail investors enter into this market.
While earlier, physical possession was the only main aim, now traders enter into this market for other goals like portfolio diversification, hedging, and speculation as well.
The digital modes of trading have made the whole process very easy. Now, people do not need to go around to trade their commodities.
The method of price discovery in the digital exchanges is handled by the market forces of demand and supply.
In India, there are the following major commodity exchanges:
- Multi Commodities Exchange (MCX)
- National Commodities and Derivatives Exchange (NCDEX)
- National Multi commodity exchange (NMCE)
- Indian Commodity Exchange (ICX)
These commodity exchanges facilitate the trade of all commodities. These commodities can be divided into the following categories:
Hard Commodities
- Precious Metals: Aluminium, copper, lead, nickel, tin, zinc, steel, sponge iron
- Energy: Crude oil, furnace oil, Natural gas
- Bullion: Gold, Silver, I-gold, Silver M
Soft Commodities
- Fiber: Cotton yarn, kapas, Cotton S staple, Cotton M staple
- Spices: Jeera, pepper, turmeric, cardamom, red chili
- Plantations: Coffee, rubber, Arecanut, Cashew kernel
- Pulses: Chana, yellow peas, Masur
- Oil and oilseeds: Castor oil, coconut oil, crude palm oil, mustard seeds, mustard oil, refined sunflower oil, refined soy oil, sesame seed, soybean, soy seeds
- Cereals: Maize, guar seeds, Sugar M-30, Potato, Gurchaku, Guar gum
- Livestock: Pork, feeder cattle, live cattle
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Price Discovery process in the Commodity Market
The price discovery process in the commodity market is affected by various factors other than the demand-supply equilibrium.
Some of the significant determinants of price are:
- Weather forecasts
- Government policies
- Inflation rates
- Market dynamics
- Expert opinions
- Hopes and fears of buyers and sellers in the markets
- Expectations of participants
All these together help determine the price of different commodities on the exchange. In order to get a fair idea of the market behavior, a trader needs to keep in mind all these factors.
To become a successful trader, information about all the global happenings needs to be kept.
How to Trade in Commodities?
Just like stocks and derivative contracts, a trader can buy and sell commodities. However, in commodities, there are two options.
Either the trader expects to get physical delivery of the product, or he just enters to book short term positions using futures contracts. The latter is more popular.
The trader assumes this position after considering various technical and fundamental factors affecting the prices.
The main objective while taking a long position is an expectation of appreciation. Whereas, when a trader takes a short position, he is sure of a fall in the prices.
Step by Step guide to Commodity Trading in India
- Selecting a commodity broker and open a trading as well as Demat account. This is the first and foremost step in your journey towards becoming a trader.
- Acquire an understanding of all the market instruments. 100+ commodities are traded on exchanges in India. To become a successful trader, it is crucial to know everything about the commodity you wish to trade-in.
- Understand the market: Before trading with actual money, it is always advisable to do some paper trading to get a clear understanding of the market movements. The aim of trading should be not only profit maximization but also risk management.
- Make an initial deposit in your Demat account, and start trading!
No trader should start his journey with unrealistic hopes like earning from day one or always ending up in profits. These goals will only make you make the wrong decisions.
Market tests your patience at every level. It is important to stay determined and practice everyday. The commodity market is precarious, and hence, any wrong decisions can cost you huge!
Understand in Detail about Commodity Market here
| Learn about Commodity Options | Commodity Exchanges |
| Learn about Commodity Futures | Commodity Trading Tax |
| What is Hedging in Commodity? | What is MCX? |
| Commodity Market | What is NCDEX? |
Why Commodity Trading is good?
Portfolio Diversification: No smart investor blocks all his funds in one type of asset. Commodities are a great way of diversifying your portfolio and minimizing the risks caused by the stock market.
The commodity markets offer a high return potential, and hence, is an excellent place to diversify.
Inflation Protection: Trading of commodities through futures contracts helps the investors in saving themselves from inflation.
The prices of commodities, especially agricultural commodities, are affected highly by inflationary pressure.
Allocation of Surplus Funds: It is always better to earn some return than zero returns. Due to the inflationary pressure, zero returns are actually negative returns.
This means funds kept idle are not useful in any manner. Hence, it is always a good idea to use those funds in commodity markets.
This market is highly liquid. Therefore you do not have to worry about exiting. You can exit anytime you want. Also, there is high leverage, so the possibility of returns is also high.
Risk Management while Trading in Commodities
If you talk to any expert trader, the first rule of trading they will tell you would be to manage your risk. Never take risks that you cannot afford.
Risk management is as important as earning profits. From day one, the trader needs to know his risk appetite and should take positions accordingly.
The best way to manage your risk is to keep strict stop losses and never answer margin calls. By doing this, you can always ensure that you lose only as much as you can afford even if you make a wrong decision.
Types of Risks a Trader is exposed to in Commodity Market
Credit Risk: In exchange-traded contracts, the scope of counterparty defaults is very low. Hence, the credit risk is also very low.
Legal Risk: The commodity exchange and all trades conducted are highly regulated by the SEBI. Many activities and trades are prohibited, and indulgence in these activities can cause legal risks.
Liquidity Risk: In case a trader takes a position in the market that lacks liquidity, it would be difficult for him to square off and exit.
Market Risk: Markets are always unpredictable. Hence, the risk of any upside or downside move beyond the expectations of the trade can happen.
Operational Risk: Often, the trader may have to bear losses because of issues in the broker’s systems, connectivity issues, and similar operational problems.
These risks can be minimized by choosing a good broker who provides services like trade on call.
Benefits of Commodity Trading
Below listed are some advantages of entering into the commodity market:
- The commodity futures market is highly leveraged. This means, even with a small investment, the earning scope is very high.
- The entry and exit in the commodity market can be very easy. This is because of the high levels of liquidity. However, it is important to understand that this is not the same for all commodities.
- Portfolio diversification is one of the main aims of entering into the commodity market.
Cons of Commodity Trading
Below listed are some disadvantages one faces in the commodity market:
- There is high volatility in the commodity market. This means high risk.
- High leverage makes the markets riskier. The higher the leverage, higher are the chances of both wins and losses. This simply means you can both win big or lose big.
Commodity markets are very risky. Especially for beginner traders, the markets pose a high risk. Hence it is advisable to first acquire full knowledge before entering the market.
Those who do trading as gambling tend to lose often! Markets are much more than just luck.
Commodity Trading Hours in India
The commodities can be traded in the hours of operation of the commodity exchanges. In India, the timings are 10:00 am to 11:30 pm. During these hours, the traders can take any positions in the markets.
To ensure that you have hassle-free trading experience, you need to choose your broker wisely. The broker needs to have a robust platform that can provide real-time updates of all the positions without any lags.
Commodity Transaction Tax:
The traders need to pay a commodity transaction tax. The CTT is levied on all transactions done on domestic commodity futures exchanges.
The revenue raised by the government through CTT is utilized for different purposes. The process of collection of the tax is highly transparent and efficient.
Apart from the CTT, the trader pays stamp Duty, brokerage, and other charges levied by the brokers to maintain the account.
Top Commodity Trading Tips & Techniques
The commodity market has a high reward potential, but this also means a high-risk potential. Below are five tips to become a highly successful commodity trader:
- It is important to understand that commodities are physical products whose production depends on several factors. Some of the factors like wars or natural calamities are beyond the control of humans. Hence, only limited capital should be invested in this market.
- The nature of different commodities needs to be understood before entering into trades. For example, some precious metals like gold are considered relatively safer than others. This is because of the increasing demands and limited supply. The price appreciation is easy to expect. Not all commodities behave in a similar manner. Hence, there is a need to understand the nature of the commodity to analyze the risk associated with the trade.
- Keep a regular track of the markets. It is not imperative to take trade everyday. Assume a position only when you are sure of it. Keeping a regular check on market performance of different commodities helps to decide the right entry and exit points.
- Do not fall for leverage. Commodity markets are considered very risky because of the high leverage available. For experienced traders, leverage acts as a help; however, for beginners, leverage can become a cause for huge losses as well.
- Do not take it on your ego. Many beginner traders make this mistake and try taking positions just to satisfy their ego without analyzing the technical well. It is always better to accept that you made a wrong trade and exit than trying to rectify the mistake by making further wrong decisions. This will only cause huge losses in the long run.
Conclusion: Commodity Trading
Commodity trading is one of the best avenues to divert your surplus funds to. However, before entering the market, one needs to equip themselves with the necessary knowledge about how this market functions.
Commodity trading can give good returns if done smartly. It is only with patience that one can gain expertise in the market.
By carefully managing your risks and analyzing your profits, no matter how small they are, one can become a successful commodity trader.
Commodity Trading FAQs
Ques – How can I learn commodity trading?
Answer – Digital modes of learning and doodle have been made entirely easy. People do not know need to go around to trade their commodities alone about the basics of doing so. The method of price discovery in the digital exchange arena is handled by the market forces of demand and supply and will ensure you running on how to trade in a better and smooth way.
Ques – How to lower the risk in commodity trading?
Answer – Number one rule will be to manage your own risk and never invest into something you think you cannot afford later on. The trader needs to realise that he should take positions accordingly. Keep strict stop losses and never answer margin calls, per se. This would allow you a complete assurance that you will lose only as much as you can afford.
Ques – What are the benefits of commodity trading?
Answer – Commodity futures market is highly leveraged which means even with a small investment, the earning price is pretty hefty.
- Entry and exit in the commodity market can be extremely efficient and simple.
- Portfolio diversification is one of supreme goals of entering commodity market.
Ques – What are the disadvantages of commodity trading?
Answer – High volatility in the commodity market.
- Commodity markets are pretty risky for beginners’ traders.
- Having total knowledge of the market and the stocks would ensure you do not lose anything from your stack.
- Those who gamble in the market would lose much more.
Ques – What is CTT or commodity transaction tax?
Answer – CTT is the tax paid by the traders who do commodity trading. It is levied on all transactions which are done on domestic commodity futures exchange.
Ques – What are the useful tips and techniques in commodity trading?
Answer – Limited capital should be invested in the market.
- The nature of every commodity needs to be understood beforehand.
- You need to keep a regular check of the market.
Ques – What is the timing of commodity trading in India?
Answer – Commodity trading Can be done between 10 AM to 11:30 PM. At this time, the traders contest which ever position they want inside the market.
Ques – What are the types of risks involved in commodity trading?
Answer – Credit risk: in contrast that consist of exchange traded, the scope of counter party default is very low.
- Liquidity risk: If at all the trailer takes a position in the market which lacks liquidity it will be extremely tough for him to square it off.
- Legal Risk: commodity exchange can result in risks from SEBI regulations
- Operational Risk: Sometimes there might be issues because of some problem in the broker’s system, such as that of connectivity.
- Market Risk: risk of any upside or downside movement in the market which is pretty unpredictable can result in losses.
Ques – What do you mean by hard commodities in commodity trading?
Answer – Hard commodities and commodity trading mean aluminium, copper, nickel, zinc, sponge iron, energy in the form of crude oil natural gas or furnace oil and bullion which include gold, silver et cetera.
Ques – What do you mean by soft commodities in commodity trading?
Answer – Soft commodities in commodity trading means Fibre, spices, plantation, oil, cereals, livestock and pulses.
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