In common parlance, the word “commodity” takes on different meanings for different people. To lay people, a commodity may be a product, something we use or consume in our daily life. To traders, it stands for an asset that is traded on an exchange. In this sense, while you talk of investment, or trading, a commodity is any raw material that is used to produce a finished good or product. Therefore, when taken as a raw material in a particular category, commodity trading represents trading of commodities for a profit. Just as you trade stock of a company, you can trade different commodities too.
As mentioned earlier, a commodity, as it is represented in the activity of trading, is a raw material. Commodities include metals, both base (copper and zinc) and precious (silver, gold and platinum), energy (natural gas and oil) and agriculture (crops like cotton). In plain language commodity trading implies the purchase and sale of raw materials. This makes it the foundation of the international economy. Traders who want to trade in commodities, or investors wishing to invest in the commodity markets, directly, have to open a demat account.
Broadly speaking, commodity trading is done in one of two ways. You can conduct physical trading in which materials are shifted from point A to point B and bought and sold in a physical sense. The other way involves financial trading, which is what traders are engaged in at commodity exchanges. This means that traders buy commodities and then sell them for profit and gains. The most preferred commodities to trade in are crude oil, gold and base metals. In the financial world and the arena of investment, stress is given to commodity markets as they are the key spots for traders and investors to trade commodities like they trade stocks.
Commodities may be traded on the spot markets or typically, at exchanges in India. Traders are permitted to engage in trading activities by buying and selling commodities on the spot or via derivatives contracts like futures and options. Here, traders form agreements to buy or sell certain commodities at a fixed price on a preset date. Whether prices fall or rise, the transactions must take place according to prices and dates predetermined by the contracts bought by traders. In futures contracts, the transaction is an obligatory part of the agreement and a trader must buy or sell whether a profit is to be had or not. However, commodity trading in options contracts gives traders the right to buy or sell commodities, but there is no obligation to carry out transactions.
The price of commodities generally tends to move in a direction that is contrary to stocks. Hence, the commodity markets are a good way to hedge against the volatility of equity markets. Additionally, you will see more action in commodity markets when equity markets are facing periods of extreme volatility. Almost always, the prices of commodities are dictated by the factors of demand and supply, as well as economic and political conditions in any given country (of course, demand and supply would be interlinked with such variables).
Commodity trading offers great opportunities for portfolio diversification, if you have invested in the stock market. If you invest in commodities by buying stocks of companies that produce commodities, you will have to open a demat account. To trade futures and options, you will not have to do so. In case you are thinking of an upcoming IPO for investment along with stocks you already have, you can have a go at commodity trading too.
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