What is Commodities Trading? | LKP Securities
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Author Image LKP - Commodity & Currency Research & Advisory
Commodity | August 16
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What is Commodities Trading? A Thread

All of us are extremely fluent in the understanding of a commodity, which is a collective organization of a good or that are crucial in the everyday working of our lives and pose an effect on our routine, for instance, food, metal, oil, etc. so, to translate the same in a financial term, a commodity is deemed as anything that is fit for sale and buying purpose and is movable by nature, except, of course, money and actionable claims.

The procedure of dealing in this buying and selling of these movable goods is known as commodities trading. Commodity trading dates back to centuries ago when it first started and continues to maintain its importance in today’s deal market, despite the monopoly shared by the stock market and share markets.

The commodities market is driven by the first law of economics which is based on supply and demand. A change of graph in supply poses an effect on the said demand of the commodity, thereby fluctuating the commodities market. Thus, any disturbance in the environment, cultural sector, technological sector, and economical sector of a country directly impacts the trading of commodities.

What are the types of commodities for trading?

Generally speaking, commodities are classified into four categories that undergo trading behavior. These are:

?   Metals: Precious metals as gold, silver, copper, and platinum form the palette for metal commodities. During a boom in markets, the investors may be lured to invest their resources in some precious and costly metals, like Gold, which further leads to yielding profitable returns owing to their status structure, their reliability, and their conveyable value in the market. This investment may also arise as a shield against currency devaluation or periods of inflation, resulting in optimum results even then.

?   Energy: The real gems of the investment market namely, crude oil, heating oil, natural gas, and gasoline belong to this section of commodities. This is a rather significant section of the commodity markets as the demand for energy products is always going to soar high in the sky, especially with the economic developments all around the globe, leading to skyrocketed price hike of them. However, interested groups of investors should always have a thorough peek of knowledge related to OPEC (Organization of the Petroleum Exporting Countries) and new advancements in the field to carry on a positive streak of investment.

?   Agriculture: The benefits of quality agriculture is not limited to health but is also extended to wealth. Agricultural products such as wheat, rice, cotton, sugar, corn, coffee, etc are known to be extremely volatile during the transformation of weather and hence pose an investment opportunity accordingly. The mantra behind agricultural investment is dependable on the fact that a bigger population in association with the limited supply of agricultural products, tends to yield returns.

?   Livestock and Meat: Commodities that deal in flesh and bones of other consumable animals, like pork bellies, chicken, etc.

Like various equity investments, the exercising body of control for commodities trading Stock Exchange Board of India (SEBI) after the successful merger of Forward Market Commission (FMC) in it. Under SEBI, there are six potent commodity exchanges present in our country. These are:

?    The Universal Commodity Exchange (UCX)

?    National Multi Commodity Exchange (NMCE)

?    Ace Derivatives Exchange (ACE)

?    Multi Commodity Exchange (MCX)

?    Indian Commodity Exchange (ICEX)

?    National Commodity and Derivatives Exchange (NCDEX)

Steps to trade in Commodities.

?   Choose your market: The first step in commodities trading is to choose the sector or type of commodity you are interested to invest in.

?   Buying or Selling: The investors, after attaining a thorough knowledge of the commodities along with other factors that might pose an influence on the market of said commodities, decide whether they wish to buy a commodity and keep investing in it, or they wish to sell the commodity.

?   Decide on the size of the trade: Before beginning with an investment portfolio, make sure you are aware of the size of the trade that you wish to indulge in.

?   Meet your risk: The investors in commodities trading are presented with a range of stop loss orders to choose their degree of risk, along with guaranteed stop loss orders. In this format, the traders are guaranteed to take away a specified price at the closing of the trade, regardless of the condition of the market. However, this special advantage of Guaranteed Stop Loss Orders is distributed at a premium price.

?   Keep a track of your position: Once you commensurate your trade, make sure to keep a clear track of your commodity and its position to estimate real-time profit and loss.

Investment in Commodities

A futures contract is one of the best methods to invest in commodities trading. Like currency futures trading in India, commodities futures trading is a stated agreement that provides the right to an individual to buy or sell a certain quantity of goods at a fixed amount, somewhere in the future, as fixed. Futures trading is a method that is available on every set of commodities and acts as protection that cushions any price shock that may arise at any time.

Difference between commodity trading and equity trading

Two of the most dynamic investment sections of financial markets are equity and commodities trading. While one facilitates the returns from a company listed on the exchange, the other pours in returns from the transactions on everyday goods. Some of the other points of difference between the two are:

?   Freedom of Ownership: The investors dealing in equity trading are entitled to a share of the ownership of the company in action. Whereas, this is not true for commodity trading. The commodity investors do not own an ownership right as part of their trading.

?   Length of trade: Commodities trading is suitable for investors who are looking for short term investment as the contract for commodity trading carries an expiry date. As opposed to this, the equities are usually for investors wishing to have a long term investment portfolio as they do not carry a contract of expiration.

?   Hours of Trading: Commodities trading takes a longer duration to trade in comparison to equity trading. 

?   Bid-ask spread: The word for measuring the level of liquidity, is lower for stocks as compared to commodities trading. This means the highest amount that a buyer is ready to spend on buying the stock is higher than the lowest amount the seller is ready to accept.

?   Margin Requirement: This is lower for commodity trading as opposed to equity trading.

While these may be strong points of difference between equity and commodities trading, the rate of interest is a key similarity between both. Both these instruments of the financial market are affected by the prevailing rate of interest in the market.

Both new and experienced investors have a plethora of options to invest their resources, each yielding different returns, in different periods of time, and carrying different tags of risks. Though commodities trading is one of the finest methods of investment, allowing the users to directly take part in the financial movement of the economy, they are prone to a higher degree of risk arising from the uncertainties of the market due to disasters, pandemic, weather conditions, and more. For those who have a lesser thick skin to risk, there are several other investment types available to yield good returns.

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