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In India, the Commodities Market is relatively untapped and underdeveloped. Owing to the risk involved and the cyclical nature of commodities, investors refrain from venturing into this segment. However, it’s a lucrative investment avenue that may be used as a diversification and hedging tool.
This article sheds light on how to trade in commodities and gain profits.
A commodity market is a platform where raw materials or primary goods are bought and sold. It brings together buyers and sellers of items like metals, energy resources, and agricultural produce. These markets allow trading both for immediate delivery (spot market) and for future dates (futures market). The main purpose of a commodity market is to provide fair prices, reduce risks for traders, and ensure the smooth exchange of goods.
Commodities are goods that are used in everyday life. These can be exchanged for cash or other goods. Commodities include an array of items ranging from grains, oil, natural gas to crude oil, diamonds, etc.
Prices of commodities are determined by the law of supply and demand. The more demand for something, the more expensive it will be. Conversely, the lower the supply of a good, the higher the price. There are other dynamics that govern the price of a commodity, such as government intervention, the cost of production, geopolitical issues, etc. Thus, commodities are high-risk securities.
Like stocks, you can buy and sell a commodity from an Exchange. The trade in commodities is carried on at the spot and futures markets. In the spot market, commodity trading is instantaneous, and so is the settlement. In the futures market, commodities are bought and sold on standardised futures prices and settled when the contract expires.
The purchaser of the futures has the option of buying the underlying item on the stated expiry date, but the seller has to sell. Options contracts for trading commodities are another type of trading instrument available to commodity traders. This gives traders the right, not the obligation, to buy or sell a commodity at a specified price on a fixed date in the future.
The two main exchanges for commodity trading in India are as follows:
It is under the ownership of the Ministry of Finance and regulated by SEBI. Various commodities are traded on exchanges, which are broadly divided into –
The list is indicative and does not include all the commodities that are traded on MCX.
An MCX broker acts as an intermediary between the exchange and the investor or trader. To commence trading, a commodity trading account must be activated with a commodity broker. The account may be opened online or offline.
Basic documentation, such as an application form, KYC documents, bank details, and income proof, is required. A member-client agreement is to be executed with the broker. Lastly, the commodities trading account needs to be linked with a demat account.
Trading in commodities is slightly different from trading in equities. The ticket size and the value of trades are comparatively higher in the commodities market. Because of this, such trades involve maintaining margin money, mark-to-market settlements and effective delivery.
Before executing a trade, an investor is required to maintain an initial margin in his or her commodity trading account. The initial margin is between 5 and 10% of the total contract value. Subsequently, the investor may place an order through his broker by intimating the number of lots and the contract value. The investor may also need to provide a maintenance margin to cover losses in case of any adverse, unexpected price movements. The broker may make a maintenance margin call if required.
The clearing house releases the settlement price for each commodity after the end of the trading day. The difference between the contract purchase and settlement prices is cleared on a daily basis. The amount is debited or credited to the investor. This mechanism of daily settlements is referred to as ‘mark-to-market’.
A commodities contract can be terminated in two ways:
The delivery of goods is rare today. Most contracts end with cash settlement. This means traders pay or receive the difference in price, not the goods..
Commodity trading can be risky because prices often change quickly. To reduce risks and increase chances of profit, traders use different strategies. These strategies help them decide when to buy, sell, or hold commodities.
Traders follow the overall market direction. They buy when prices move upward and sell when prices move downward.
Prices often move between a high and a low level. Traders buy near the low range and sell near the high range.
When prices break out of their usual range, traders enter the market. A breakout usually shows that prices may move strongly in one direction.
Producers and consumers use this strategy to protect themselves from price changes. For example, a farmer may hedge against falling crop prices.
This involves buying a commodity from one market and selling it in another where the price is higher. They profit from this price difference.
Traders react to news and policies related to global events. Such events often affect the demand and supply of commodities.
Traders use options contracts to trade with limited risk. They gain the right, but not the obligation, to buy or sell commodities at a set price.
The commodity market moves fast. Prices rise and fall every day. It is exciting, but it is also risky. To make profits, you need a clear plan. If you are wondering how to invest in commodities and maximise your gains, here are some tips for you:
Commodity prices follow a cycle. They depend on supply and demand. Global events also shape the prices.
Agricultural products often exhibit seasonal patterns. Wheat or rice typically costs more before harvest. Typically, when new supply comes into the market, prices go down. Energy goods, such as oil or gas, are different. Their prices can change with the weather and global demand. Political tensions can also influence them.
When you know the cycle, you can guess the price moves better. This helps you enter and exit trades at the right time.
Commodity prices can change in seconds. A storm, a policy change, or a sudden shortage can shake the market. This makes commodities very volatile.
Volatility can bring profits. But it can also bring significant losses. Smart traders respect it. They use stop-loss orders to limit losses. They spread money across different commodities. They also follow the news closely.
With the right approach, volatility becomes a tool, not a threat.
Commodity trading is not for the faint-hearted. The market can move quickly and leave traders surprised. But it also presents lots of opportunities to create wealth when approached with intelligence. The trick is to align your strategy with your risk tolerance. A disciplined approach shields you from significant losses.
It depends on the commodity and the leverage from your broker. Some traders start small. More capital gives more safety and better options.
Popular ones are rice, wheat, sugar, gold, silver, copper, crude oil, and natural gas. These trade on MCX and NCDEX.
It adds variety to your portfolio. It can protect against inflation. It also gives profit chances in both rising and falling markets.
MCX stands for Multi-Commodity Exchange of India. It is a major trading platform for metals, energy, and farm products.
Options are contracts. They give you the right to buy or sell at a fixed price within a time limit. They reduce risk but still allow profit.
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