As a beginner, you may only look forward to making investments in the stock market and letting them compound over time. Now, that is perfectly fine, but once you have put your foot in the stock market, you may want to explore the other available ventures. So, many investors and traders eventually may look at the commodity market and want to start commodity trading.
The commodity market, in a way, is somewhat similar to the stock market, with the primary differentiating factor being—traders in the commodity market trade commodities. Raw material like and agricultural products like copper, gold, crude oil, and wheat classify as commodities. So, generally when one refers to commodity trading they are talking about trading derivatives of commodities like the ones mentioned above. We cover this aspect of the commodity market in greater detail later in the article.
How to Start Trading Commodities?
Similar to how stocks trade on the stock exchanges like the BSE (Bombay Stock Exchange), commodities trade on the commodity exchanges like the MCX (Multi Commodity Exchange). Besides the MCX, the other major commodity exchanges in India comprise the NMCE (National Multi Commodity Exchange and the NCDEX (National Commodity and Derivative Exchange).
Likewise, trading commodities requires a separate account called the commodity trading account. Like regular trading accounts and demat accounts, commodity trading accounts are also provided by stockbrokers. Most leading stockbrokers offer all the three accounts mentioned above. So, there is a good chance you can open a trading account for commodities with the same broker with whom you have opened a demat account. So if you already have a trading account, check if you can activate the commodity trading segment.
If you do not have a regular demat to trade stocks, consider opening one with a broker that also offers trading services in the commodity segment. It would be best if you thoroughly assess various brokers’ features and fees before proceeding to select a broker.
Ways of Trading Commodities
Commodity trading can be executed by physically trading the commodity. However, as a trader trading through their demat account opening app that is impractical. You would not want to physically go to a marketplace selling agricultural products or metals as that would be an arduous process. You can also trade commodities indirectly by trading commodity stocks and exchange-traded funds (ETFs). However, generally when we refer to commodity trading, we refer to the trading of commodity futures contracts over the commodity exchange. So, if you are familiar with futures trading, you will find it easier to start with commodity trading.
What are Commodity futures?
Futures contracts state an agreement between a buyer and seller to trade an underlying asset at a specific price of a future date. In the case of commodity trading, the underlying asset is a commodity. If the trader expects the commodity to appreciate in value, they take a long position. In contrast, if they expect the price to fall, they take short positions.
However, futures trading takes place in lots. What that means is, when you trade futures, you are dealing with multiple units of the underlying asset. For instance, a single lot of crude futures may contain 100 barrels of crude oil. But, at the same time, in futures trading, you are not required to pay the entire amount upfront. Instead, after you open your commodity trading account you deposit, called margin, which is generally 5-10% of the contract’s value.
Now the main reason, commodity trading is primarily carried out in the form of futures trading is because unlike equity commodities do exist in the electronic form. Trading commodity futures makes it convenient to carry out commodity trading over the internet using your demat account opening app. Moreover, commodity futures contracts are mainly cash-settlement contracts. So, your net profit/loss is adjusted from your bank account. That is because as a retail investor, it is very unlikely you would wish a delivery of the commodity.
That said, commodity trading is not a piece of cake, the primary reason being you are dealing with futures. Futures trading necessitates trading discipline, a robust strategy and experience. They are high risk, high reward trades and even a small fluctuation in the commodity’s price can result in substantial gains or losses. At the same time the barrier to entry is also high in terms of capital required. However, when done right it can be a very lucrative avenue.
Once you discover how the price of commodities like metal and crude affect the other financial markets, you can start trading commodities to take advantage of commodity price fluctuations. Commodities also work as a hedge during inflation. So, during an inflationary period when the stock market is bearish, a commodity trader can still make their money.