A Beginners Guide to Commodity Trading - Motilal Oswal
A Beginners Guide to Commodity Trading - Motilal Oswal

Beginners Guide to Commodity Trading

Trading commodities has been an age-old practice that has evolved over the years. There is a wide range of commodities today and modern-day trading takes place on exchanges such as the Chicago Mercantile Exchange or the London Metal exchange. One requires an account with a trading platform in order to be able to access the commodity markets. Before getting started with commodity trading, here is a guide to commodity trading that covers the basics you need know:

What are commodities?

Commodities are essentially materials or resources used to make refined goods. As opposed to goods, commodities are standardised; two units of a commodity in equal measure will be identical regardless of their production or origin, thus also making them interchangeable. A few examples of commodities would be iron, crude oil, natural gas, steel, cotton, silver, grains, pulses, etc.

What is commodity trading?

Similar to stock trading, wherein one buys and sells shares of certain companies, in commodity trading, you can buy and sell commodity products. Commodities are traded on certain exchanges, and traders aim to profit off the changes in the commodity market by buying and selling these commodities. Commodity trading for beginners can be made easier with Contracts For Difference (CFDs), which is one of the most straightforward trading options in commodities. CFDs are basically financial instruments that provide you a chance to capitalise on price movements without the ownership responsibility of the underlying security.

Types of Commodities

Commodities can be categorised into four main groups:

1. Metal commodities: Metals like iron, copper, aluminium, nickel are used in construction and manufacturing, while platinum, silver and gold are used for jewellery-making and investment purposes. 

2. Energy commodities: Energy sources like oil and natural gas play a major role in powering the globe, and are used for transportation, in our homes, factories, and so on. Other examples would include uranium, ethanol, coal, and electricity.

3. Agricultural commodities: Commodities such as crops and farm livestock which supply food and also contribute to other industries such as the textile industry are another category. A few examples of agricultural commodities would be sugar, cocoa, soybean, wheat, cotton, cattle and hogs.

4. Environmental commodities: This group includes renewable energy certificates, white certificates and carbon emissions.

Commodities can also be categorised as hard and soft commodities. Hard commodities are natural resources that are extracted out of the ground, or mined. These would include copper, oil and gold. The other type is soft commodities, which include agricultural products like sugar and cotton or farm-raised livestock.

Why trade commodities?

For investors who are trying to diversify their portfolio, commodity trading is a good option. Here are a few aspects of commodity trading for beginners  to consider:

1. Trading opportunities: As commodity prices are generally quite volatile, this acts in favour of the traders by opening up plenty of trading opportunities. Traders can also profit off upward as well as downward price movements.

2. Leverage: As a trader, you can control considerable amounts of money with small deposits by using ‘leverage’. This could potentially help you magnify your gains, however it’s crucial to remember that it may also magnify your losses.

3. Flexible trading schedules: Since commodity markets are open for most of the week, it allows you to trade at a time that is most convenient.

4. Diversification: As commodities have little to no correlations with traditional classes of assets such as bonds or stocks, often commodities rise during periods that see a fall in stocks and bonds, which can help lower portfolio risks for traders. However,this is not a hard and fast rule.  

5. Protective hedge against inflation: Due to unpredictable event risks such as economic crises, natural disasters, and wars can affect the economy adversely, and currencies can also lose purchasing power during periods of inflation. Commodities, which often tend to rise during such periods, can protect the trader by acting as a barrier against such events.

Conclusion:

These are the fundamentals that can help you figure out how to start commodity trading. It’s also important to consider factors such as price or leverage risk, risk management strategies and other contributing elements. Additionally, commodity prices can fluctuate with changes in supply and demand and consumer as well as manufacturing trends. You can look for a broker in order to make your foray into commodity trading easier.

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