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What is Commodity Trading?

You too can trade in commodities with confidence.

Yes you heard it right !

If you are interested in commodity trading and want to know how it works, then this brief will definitely help you in understanding the commodity market.

What is Commodity Trading ?

Table of Contents

In simple words buying, selling or trading a large range of commodities like Oil and gas, metals such as gold and silver and soft commodities like cocoa, coffee, wheat and sugar. Commodity trading is perhaps older than that of financial markets. In commodity trading, investors bet on the expected future value of a given commodity.

History of Commodity trading : 


It is as old as Sumerians of Mesopotamia who lived in modern-day Iran and Iraq. King Croesus (560-546 B.C) ruler of ancient Lydia now a Turkey stamped with his royal emblem of the facing heads of a lion and a bull on gold coins. These coins became the standard of exchange for worldwide trade and commerce. 

As a commodity trader, one should know What is commodity trading, How commodity trading works, What are the basic rules and regulations. Different strategies of trading with commodities.

Commodity Trading Strategies

You can trade commodities only through registered brokers of authorised exchanges such as NSE, MCX-SX,BSE. The Multi Commodity Exchange of India Limited (MCX) is India’s first listed exchange. The exchange started in November 2003, operates under the regulatory framework of Securities and Exchange Board of India(SEBI)

Advantages of Commodity Trading :

  1. Commodity futures offers high liquidity, It is easy to buy and sell commodity futures
  2. Metals like silver, gold and platinum protect the investor during inflation. They are certainly a good source of investment at times of economic  uncertainty.
  3. Diversified investment portfolio
  4. Lower Margin
  5. High returns
  6. Transparency in the process

What are commodity products ? 

  • Bullion: Gold, Silver.
  • Base Metals: Aluminum, Brass, Copper, Lead, Nickel, Zinc.
  • Energy: Crude oil, Natural gas.
  • Agri commodities:Black pepper, Cardamom, Castor seed, Cotton, Crude palm oil, Mentha oil, Palmolein, Rubber.tumerice, jeera, coriander, sugar,mustard seed. 

How to open your commodity trading Account ?

Those who have registered brokers with MCX or NCDEX and SEBI are authorised to conduct trades in commodities. The prices of commodities will change constantly.

Opening your commodity trading account with a reputed registered broker is the first step you are going to take. Now you can open an account both online and offline.

Documents required :

  • Filling the application form
  • Submit KYC documents. Proof of id : Passport/ Voters ID/ DL/Pan card /Aadhar card
  • Address Proof : Passport/ Voters ID/ DL/ Aadhar Card. Electricity bill/ Home rental agreement/ gas bill etc
  • Agreement needs to be executed on a Non-judicial stamp paper between A member and client.
  • Submit the Income Proof 

 a. Statement of you business account

b. Six months bank statement

c. Net worth certificate

d. ITR copy for Form 16

e. certificate of demat holding

The above documents can be uploaded online to your brokers portal or you can submit the documents at the brokers office.

Nominal account activation fee will be collected by a broker. Once your account is activated, you will be getting your trading ID and login ID wherein you have to set your login password

Now, you are good to go and place your orders. But, before that, let us understand the different  strategies used for trading. 

What is tick size in commodity trading

What is tick size in commodity trading ?: 

The minimum upward or downward movement in the price of a security is measured as tick size. It also refer to the change in price from one trade to the next trade

What is hedging in commodity trading ?:

Hedging is a best way to reduce risk against exposure by taking an offsetting position in a related product. In other words, investors hedge one investment by making trade in another  thereby reducing risk.

Advantages of hedging : 

  1. Hedging reduces price risk associated with the physical commodity
  2. Hedging can be used to protect price risk of commodity for long periods by rolling over contracts
  3. Hedging makes business planning more flexible .
  4. Hedging can also facilitate low cost financing limitations.
  5. Hedging also protects you fully against adverse price changes.

Limitation of Hedging :

  1. Cannot eliminate the price risk in totality due to the standardised futures contract.
  2. Profits are limited in hedged trades.

What is lot size in Commodity trading ? 

A lot represents the minimum number of units of a commodity that is traded on an exchange. Each commodity has a different lot size.

Commodity

For ex,

Aluminium lot size –  5 MT (Metric Ton)

Copper                       –  2,5 MT

Cotton                        – 25 Bales

Gold                           – 1 KG

Silver                          – 30 KG

Crude Oil                    – 100 Barrels

What is spread in commodity trading ? :

Spread trading is taking opposite positions in the same or related markets. 

What is Contango ? A market condition when the value of the forward contract is higher than its spot price or the price of a contract expiring in an earlier month is lower than the price of a contract expiring in the later month  is  called Contango.

What is Backwardation : When the value of the forward contract is lower than its spot price or the price of a contract expiring in an earlier month is higher than the price of a contract expiring in a latter month is called backwardation. co

Bull Futures Spread : In the commodity market, future contracts of immediate months are more volatile by a larger quantum than farther months. Therefore, prices of immediate month contracts will rise faster. Commodity traders will buy a nearer future contract and sell one further out in the same market.

Bear Futures Spread : Bear Futures spread works exactly opposite to bull future spread. Here market price of nearer month contracts will fall faster than those of further out. In such conditions, traders will sell nearer futures contracts and buy one further out in the same market.

Inter commodity Spread : is another type of commodity in which the trader  takes a long position on one commodity ( in which he is bullish) and shorts another one( in which he is bearish). Traders will gain profit out of the difference in the prices of these two commodities, This will help the trader to hedge their risks while reducing margin  requirements at the same time.

In the present scenario, retail investors are more vulnerable to the market movement and interested in diversifying their investment in different sectors/segments. Unlike earlier days, transparency in dealing with trades has boosted the confidence of retail investors thereby venturing in the commodity market.  Commodity traders are updated with the price action in commodities by various facts such as rainfall, manufacturing output, agricultural produce etc.

It is always suggested to read and understand the process of trading and start trading with confidence and patience.

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