What is Commodity Trading?

Introduction

Commodities trading is a confusing concept at best. For the layman, commodity trading meaning is dealing in a busy marketplace, with differing prices for the same commodity, fluctuating market trends and an overall sense of chaos.

It can be a taxing task to undertake for someone who does not grasp the market. If you have always been interested in commodities trading, fret not since there are some steps you can take to learn a little more before diving into the deep end.

What Is Commodity Trading?

Commodity trading is a business of buying and selling goods produced by nature or human beings for profit. Commodity trading is broadly classified into two categories: spot trading and futures trading.

Spot trading involves the buying and selling of commodities at the current market price on a cash basis. In contrast, futures trading consists of buying and selling commodities at a predetermined price in the future.

Suppose you are purchasing an ounce of gold today, but you are also betting that tomorrow it will be worth more than what you bought it for today.

The reason for this is the inherent risk involved in trading commodities. You can buy a futures contract that will make a certain amount of money if the price goes up and lose a certain amount if the price goes down. Commodity traders use margin accounts to increase their leverage and possibilities of making profits from trades.

Examples of Commodities

Commodities can be classified according to their uses: energy commodities, metal and nonmetals, and agricultural products. Some examples of energy commodities include coal and petroleum (crude oil). Some examples of metal and nonmetal commodities include tin and copper. Some examples of agricultural commodities include sugar and rice.

Commodity trading is traded on both cash and futures. But the most common way of commodity trading is through futures.

The list of commodities in India is vast and varies from region to region, such as agricultural commodities such as cereals, sugar, rice and maize; animal proteins such as meat and dairy; metal ores such as copper, lead, zinc and iron; petroleum products such as crude oil and natural gas etc.

Basics of Commodity Trading-How Can It Be Done in India?

Commodity trading in India can be done through commodity exchanges like NCDEX and MCX and the spot market.

Commodity trading in India is regulated by SEBI (Securities Exchange Board of India), which has set up a separate category for commodity futures trading under the F&O (Futures & Options) segment. Commodity trading in India is considered speculative because prices of commodities are vulnerable to factors like rainfall, weather patterns etc.

Commodity prices are calculated by the forces of demand and supply more than by its usage. Commodity prices are mainly dependent on weather conditions and crop production.

In a commodity exchange, a trader buys a commodity from one person or company and sells it to another person or company for profit. The traded commodities include orange juice, coffee, sugar, raw wool, cocoa, copper, gold etc. In some cases, commodities can be sold as currency as well as a physical good. But most of them are sold as material goods.

What Are Futures in Commodity Trading?

Futures are agreements made with another party to buy or sell a commodity later but at an agreed-upon price. There is no obligation to fulfil the contract, only to make sure that both parties agree on the price of the commodity in question at a specific time in the future (hence it's called a futures contract)

A futures contract is between two parties to purchase or sell a set quantity of a commodity at a predetermined price. Futures contracts show the quality and quantity of the underlying commodity and establish a delivery date and location. To determine the value of a futures contract, it's essential to understand how interest rates affect its price.

The buyer and seller (usually called a 'commodity broker') agree on a price for which they will trade one commodity for another at an agreed-upon date in the future.

The Role of Exchanges in Commodity Trading

The role of commodity exchanges in commodity trading is significant. Commodity exchange has played a vital role in developing the commodity market in India.

The exchange plays an essential role in creating awareness about the product among the traders and the end consumers. The commodity exchange information about the market trend, current market price, demand-supply ratio are provided to the traders by various tools like commodity exchange bulletin, websites etc.

The active participation of commodity exchange increases competition among the market players. Hence, they are forced to provide better quality products with higher efficiency at a lower cost.

Commodity exchanges provide direct assistance to farmers by providing information about prices prevailing in the wholesale markets and advising them about suitable times for the sale or purchase of their produce. Commodity exchange also provides training to farmers about the latest techniques of cultivation and post-harvesting handling of produces.

Therefore, it can be said that commodity exchanges play a crucial role in developing the agro-based economy of India.

How Do Futures Work for Investors?

When one buys a commodity through commodity trading in India, the trader agrees to accept the commodity on a particular future date. If they decide that the cost of that commodity will increase, they will go long on that commodity.

On the other hand, if they think that the price of that commodity will decrease, they will go short on that commodity. The advantage is that you can make money regardless of whether the market is going up or down.

Wrapping Up

Commodity trading is a form of investment that involves speculation on future prices. If you are looking to invest in commodity trading in India, the above list of things should get you starting the process.