An introduction to commodity trading

You can also invest in commodities like raw materials as you invest in stocks. India has a developed commodity market, where traders trade in commodity derivatives to hedge against losses arising from market volatility. Added to investment portfolios, commodity derivatives accentuate possibilities of higher return. However, many investors avoid treading into the domain due to a lack of knowledge and fear. In reality, it is not rocket science. With proper knowledge and awareness, commodity derivatives can be a significant inclusion in your portfolio.

What is the commodity market?

A commodity market refers to a marketplace where various commodities from the primary sectors are traded. A commodity is any raw material or agricultural product that can be brought or sold. These are standardised and interchangeable with other goods.

The Indian commodity market is highly developed and regulated. You can trade in the following categories of goods in the commodity exchanges.

●     Agricultural (chana, soya, spice, rice, pulses, rubber)

●     Metal (industrial and precious metals)

●     Energy (natural gas, crude oil, coal)

To begin with, you must answer the question: what is commodity trading?

Commodity trading facilitates a free market with a price discovery mechanism to allow traders to buy and sell goods and F&O.

Basics of commodity trading

●     Commodity trading happens in a different market from equity trading.

●     Commodities are known as risky assets because their market is sensitive to external factors that are difficult to predict.

●     Investors can choose to invest in commodities through derivatives and ETFs.

●     For investors, commodities are valuable to diversify portfolios beyond traditional securities. 

Benefits of commodity trading

●     There are significant benefits of commodity trading for investors besides portfolio diversification. Returns from commodities have a low correlation to returns from other asset classes, enabling investors to balance and mitigate risk in the portfolio.

●     Secondly, commodities help create a hedge against inflation as their prices increase when inflation rises in the economy.

●     Commodity derivatives are financial instruments used to hedge against market volatility. Supply chain disruptions caused by natural disasters, wars, and economic crises can push the price of commodities. But traders can hedge against these disruptions by entering into a futures contract.   

Commodity exchange

Commodity trading happens in different exchanges. The Indian market is highly regulated, with six commodity exchanges. Before you invest in commodities, you must understand how the market functions. Here are the names of the national commodity trading exchanges.

●     Multi Commodity Exchange of India Ltd (MCX)

●      National Commodity and Derivative Exchange (NCDEX)

●     Indian Commodity Exchange (ICEX)

●     National Stock Exchange (NSE)

●      Bombay Stock Exchange (BSE)

●     National Multi Commodity Exchange (NMCE)

How to start commodity trading

Commodity trading isn’t difficult, but it may require thorough knowledge and understanding of the market. For new traders, it can be daunting. So here are some steps to start trading in goods.

Understand the market: The commodity market involves exchanges and different stakeholders. India has six significant bourses where transactions in goods happen.

Gain knowledge: You can learn about goods trading from books and online resources. Or else, joining an online investor education program will offer you thorough expertise and guidance. 

Pick a broker: Selecting an efficient and reliable broker will have a long term impact on your returns. So, choose a broker with significant experience and a track record.

Open trading account: You will need a separate commodity trading account to invest in goods. Depending on the information provided by the investor, the broker will perform a risk analysis before accepting or rejecting the account opening request.

Deposit margin: Once the account is open, investors must deposit an initial payment of 5 to 10 percent of the contract value. Besides the maintenance margin, the broker may also ask initial margin to cover any losses occurring during the trade. 

Set up a trading plan: You will need a trading plan at the final stage of the preparation. Without a strategy, it isn't easy to sustain the market in the long run.

Conclusion

Investors need patience, practice, and discipline to succeed in goods trading. It will be good to remember that strategy of one trader might not suit another, meaning one should develop their own trading strategy.

Getting a full-service broker is a good idea if you are a novice.

Finally, goods trading allows investors to use leverage to amplify their profit potential, but you should consider analysing the risk before entering a contract.