A Beginners’ Guide to Commodities Trading and Exchange
People who want to diversify their portfolio beyond shares, bonds and real estates, commodities can prove to be a better option. Commodities have a potential to become a distinct asset for skillful investors and traders. Understanding commodities is relatively simple for investors as they are more in sync with fundamental economic concept of demand and supply.
The setting up of three commodity exchanges in the country has made it easy for the investors to trade in commodity without having physical stock. However, the investors should also understand the risks associated with commodity trading before investing.
“Stock prices can go to zero.
Unlike shares in a company commodity are real things that are always likely to be worth something to somebody.”
A commodity is a collection of things or goods that is important in day-to-day life. It can also refer to essential material used to make finished goods. They are standardized, which means they can be interchangeable. They possess a monetary utility. Commodities can be in the form of food, metal, energy etc.
Classification of commodities:
- Bullion like Gold, Silver, Platinum
- Energy like Natural gas, Crude oil, Gasoline, etc.
- Agriculture products like Castor seed, Cardamom, Black pepper, Cotton, etc
- Metals like Lead, Zinc, Copper, Nickel, etc.
Commodity Trading in India
Commodity trading is the buying, selling and trading of commodities. Trading of commodities has been happening since the ancient times like barter system. The poor government policies, fragmented markets and foreign invasions reduced its popularity. But with the introduction of exchanges like MCX and NCDEX commodity trading in India is regaining its popularity.
Commodity market like stock market works in spot or cash market and futures market.
Market where commodities are bought and sold in physical form by paying cash is a spot market. The price on which commodities are traded in this market is called the spot price. For instances; you want to sell 15kg wheat you can sell it on the exchange platform on the spot price and deliver the product physically.
Market where the commodities are bought and sold by entering into a contract to settle the transaction at some future date at a specific -price is called futures market. The unique feature of this market is that you do have to hold the commodities in physical form or deliver it physically.
How to invest or trade in Commodities in India?
The best way to invest in commodities is through a futures contract. A tradable commodity can be bought and sold just like you trade in shares. You can buy a commodity, expecting future price appreciation. When the future price hits the target, you sell it. On the other side, sellers of a commodity sell it when they think there is no room for appreciation for future price.
Participants in commodity market
1. Hedgers: Hedgers are producers, manufactures, etc. who participate in commodity trading market only to hedge their risk. Their aim is to reduce risk, not make profit.
For instance; A rice farmer wants to hedge the price risk on his produce. So, he enters into a futures contract. Now, if the price of rice falls in the local market, he can sell his futures contract and make profit. In case the price rises, he can sell the produce at a higher price in the local market.
2. Speculators: Speculators are traders who simply speculate on the price of the commodity. They aim to generate short term profits through commodity trading. They do not face any risk, which needs hedging.
For instance; Rahul expects that the price of rice will go up in the coming months. So, he buys a futures contract and sells when the prices increase. This way he makes a profit without taking any long-term position or physical delivery.
Where to invest in commodity in India?
There are six major commodity trading exchanges in India:
- Multi Commodity exchange (MCX)
- National Commodity and Derivatives Exchange (NCDEX)
- National Multi Commodity Exchange (NMCE)
- Indian Commodity Exchange (ICEX)
- Ace Derivatives Exchange (ACE)
- The Universal Commodity Exchange (UCX)
In 2015, the regulatory body of the commodities trading – Forward Market Commission (FMC) merged with SEBI. Commodity trading in these exchanges requires standard agreements as per the instructions so that traders can be executed without visual inspection.
Investing in Commodity Market
Understanding the functioning of commodity market is very crucial as there are many factors that have an impact on the prices of the commodities. Demand-Supply forces result in the volatility of price; the other major reason for fluctuation is government policies, currency prices etc. There are certain keynotes that you should keep in mind:
- Knowing your risk capacity
- Use stop loss
- Have emotions under control
- Reviewing is very crucial
- Understand seasonality
- Take help of technical analysis
- Stay updated
Futures trading in commodity have emerged as a major investment option in India. These days, commodity market performance is equal to that of the stock market. Not many investors know how to tap and benefit from trading in various commodities. Here are steps you need to know to invest in commodity market:
- Locate a brokerage house with a reputation for services.
- Fill a Demat Account opening form with a registered brokerage house and a member with a commodity exchange.
- Be clear of the rules and regulations especially transaction cost.
- Choose the right brokerage plan that can optimize your costs, fees ranging from 0.03% to 0.08% on contract value.
- Be clear on the services deliverables.
- Insist on regular reports.
- Set aside funds for commodity investing, but remember not at the cost of other traditional investing avenues.
- Gather requisite knowledge and pay up the initial margin money, account opening charges etc.
- Set stop loss and book profit levels.
- Get ready for investing and track your profit or loss.
There are five ways of investing in commodity in India:
- Commodity Equity Traded Fund (ETFs)
- Commodity mutual funds
- Commodity options
- Commodity futures
- Physical commodity
Other things related to Trading in Commodities in India
Commodity trading hours: The trade timings of commodity exchange from Monday to Friday are IST 10:00a.m to 11:30p.m.
Commodity trading taxes: Traders pay Commodity Transaction Tax (CTT). In the commodity sector, GST is paid on brokerage on physical delivery of goods and on exchange chares and warehouse charges. There is also a stamp duty.
Margin Intraday Square-off (MIS): It is used for intraday trading, where you can get extra leverage.
Normal (NRML): It is used for overnight trading of futures and options. There is no worry about auto square-off.
Also Read: Taxation and Tax Saving Options in India
Pros and Cons of Commodities Trading
The advantages of commodity trading include:
- Highly leveraged investment: A relatively small amount of money can be used for bigger bet.
- Very liquid: Entry and exit are easy.
- Potential of huge profits.
The disadvantages of commodity trading are:
- Very volatile
- High risk
The Bottom Line
Commodity trading is a smart way to diversify your portfolio, but involves risk, especially for new investors. Yes, the vast market, attract many brokers to it. But with experience, proactive attitude and reliable after service support may gain mileage. You can’t get rich overnight. But with time and experience, you gradually build your creditability in the market to earn a good amount.
These days, commodity market performance is equal to that of stock market and analysts predict that the commodities market will overtake capital market in trade volumes sooner than later. But you should always keep in mind that high leveraged nature of the market can make you win big or lose big.
Most importantly, being successful at commodities trading requires a lot of hard work and dedication that the trader must make himself prepared for!
But, Be Bold!!!