What is Commodity Trading? 7 Things Every New Trader Should Know

While it is now that investors and traders have started taking an active interest in the commodity market, it is one of the oldest asset classes in India.  It was in 1875 that the first organized commodity trading centre, the Bombay Cotton Trade Association, was established in India.It is not wrong to say that this laid the foundation for futures trading in the commodities segment in the country. Fast forward to the present, and we now have six national commodity exchanges in the country where you can trade several commodities, ranging from Gold, Silver, Crude, Cotton, Wheat, Natural Gas, and a lot more.Apart from the national exchanges, there are more than twenty regional commodity exchanges in the country. If you believe that commodity trading or investing is for you, it is time for you to start mastering the basics of this market. So, what is commodity trading ? What are the things that beginners should know about the commodity market? Here is a list of top 7-

There are more than twenty commodities that you can trade in India. All of the different commodities can be classified into two categories- Hard commodities and soft commodities. These commodities are further divided into other categories. Take a look-

Hard Commodities

• Energy- Crude Oil, Natural Gas, etc.
• Metals- Copper, Nickel, Lead, Zinc, Aluminum, Brass, etc.
• Precious Metals- Gold, Silver, Platinum, etc.

Soft Commodities

• Agriculture- Cotton, Wheat, Soybeans, Salt, Corn, Coffee, Rice, etc.
• Livestock and Meat- Pork, Live Cattle, Feeder Cattle, etc.

While there are currently six nationalized commodities exchanges, most commodity trading is done on Multi Commodity Exchange (MCX) and National Commodity and Derivatives Exchange (NCDEX). Most stockbrokers in India are also commodity brokers. So, if you already have an equity trading account, you can get the commodity segment activated in the same account.If you already have a stock trading account, and your broker is also a commodity broker, you can get the commodity segment activated by submitting a “Member-Client Agreement.” You will have to fill in your Demat account details, personal details, etc., on this agreement along with your signature. Submit the agreement, and the commodities segment will be activated in the same trading account.Also, the trading time for the commodity market is different than equity. Currently, you can trade non-agri commodities on MCX between 9 AM and 11.30 PM. However, agri commodities can only be traded between 9 AM and 5 PM. The trade timings are also revised at regular intervals.

All the different commodities are mostly traded through futures contracts on exchanges. If you have traded stock futures in the past, it shouldn’t be difficult for you to understand commodity futures. You can buy/sell a futures contract of any commodity and close your position before expiry, irrespective of whether the said position is in profit or loss.Alternatively, you can also trade in commodity options. In this, you can buy/sell call (CE) or put (PE) options as per your prediction about how the price of a commodity will move until expiry. Commodity options are generally used by professional commodity investors or traders for hedging their futures positions.

The contracts, be it futures or options, are traded in lots. A particular commodity, such as Gold, has many different lot sizes to choose from. For instance, you can trade in Gold (1kg), Gold Mini (100gms), Gold Guinea (8gms), and Gold Petal (1gm).Just as the lot sizes are different, so is the quoted price. In other words, if you want to trade in Gold (1kg), you will not see the price of buying/selling 1kg Gold on exchanges. Instead, the quoted price will be that of 10gms. It is the same for Gold Mini (100gms) as well. But for Gold Guinea (8gms), the quoted price will be of 8gms, and for Gold Petal (1gm), it will be of 1gm.

Another very important thing every new commodity trader should know is the tick size. The tick size is the smallest price change of any security. For instance, if the price of Gold moves up or down, it will at least move by its minimum tick size. The tick size varies based on the lot size.For Gold (1kg), the tick size is Rs. 100/tick as the quoted price is of 10gms, but the lot size is 1kg. So, for every point, the price of Gold rises or falls, you will see a Rs. 100 movement in your P/L. Similarly, for Gold Mini (100gms), the tick size is Rs. 10/tick. For Gold Guinea (8gms) and Gold Petal (1gm), it is Rs. 1/tick. Just like Gold, the lot sizes and tick sizes vary for all the different commodities.

Rather than paying the full cost of the commodity futures contract, you can buy/sell commodities by only having the margin amount in your trading account. This is generally 5%-10% of the actual contract value. For instance, if the cost of a Gold (1kg lot size) contract is Rs. 50,00,000 and the margin requirement is 10%, you can purchase it for Rs. 500,000.Apart from this, you must maintain some additional margin to accommodate the losses (if any). This is generally 2%-3% of the price of the contract.

Now that you have some basic knowledge about what is commodity trading , let us take a quick look at who should trade them.Both hedgers and speculators can invest or trade in commodities. Hedgers can hedge their positions in many different ways by purchasing or selling commodities future or options contracts. Many hedgers also use the physical settlement method of commodity trading.Speculators, on the other hand, work on the principle of predicting the market movements to make their buy/sell positions. But unlike hedgers, speculators generally do not opt for physical settlement. They close their positions before expiry and settle the contract in cash.However, irrespective of whether you want to hedge or speculate, do note that some commodities are very volatile. Factors such as demand and supply of the commodity, global scenarios, speculative demand, and several other external factors can significantly impact commodity prices.

Just as the equity market , the commodity market can also reward you, but only if you have the right amount of knowledge and experience. In many ways, the commodity prices are more difficult to predict than the equity market, as there are several global factors involved.If you are interested in commodity trading, ensure that you first learn the intricacies of the market as it is very different from the equity market. Start small and keep learning to generate consistent profits from the commodity market. If you are a speculator, aim for steady profits rather than expecting the market to reward you beyond your skills and experience.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.