Indian investors and traders have mostly concentrated on online trading of stocks, despite the fact that global commodities markets are larger than equities. One factor is the relative ease with which commodities may be traded compared to stocks. Even an Indian housewife keeps a careful eye on gold prices, even if she has no intention of purchasing the gleaming metal. A farmer, for example, monitors cotton and sugar prices on the market on a daily basis but seldom uses it to hedge his crop.
Despite their modest penetration, commodities markets have grown rapidly. Given commodities' strong trending nature, it makes more sense for traders and regular investors to choose an alternative asset class, particularly as equities markets are heating up across the board. Apart from agriculture, roughly 58 percent of India's economy is directly or indirectly tied to commodities, hence commodity trading makes sense for a variety of stakeholders.
To diversify one's portfolio, commodities may be coupled with stock and debt. Commodities have the advantage of being less volatile both intraday and over longer periods of time. Furthermore, its patterns are more secular, which is particularly true in the agricultural commodities market.
Commodities trading is significantly simpler for ordinary investors since it does not need the same level of fundamental study as stock choosing. It's a simple question of supply and demand. Agriculture commodity prices tend to fall if the monsoon is favorable, and they tend to rise if it is below average. Similarly, when the global economy is thriving, demand and prices for hard commodities like metals tend to rise, and when growth is slow, demand and prices tend to decline.
In summary, there are just a few factors to keep track of while monitoring a commodity. Commodity cycles are longer-term than equity cycles, hence they tend to trend longer. Furthermore, since they are extremely liquid markets that are internationally interconnected, it is impossible to manipulate them, making it simple for traders to participate. Trading is permitted in India via futures exchanges, which are rigorously regulated by market regulator SEBI since the Forward Market Commission was amalgamated with it. There are now three commodity exchanges where commodities may be traded.
It is as easy as opening a demat account with your local broker if the broker is a member of the commodities exchanges for an online trader who wishes to engage in the commodity markets. Because commodity volatility is minimal, the margin needed to trade is similarly low. With a tiny margin of Rs 5,000, one may create a stake.
Margin requirements are in the 5-10% range, compared to 30-40% in individual equities on the stock exchanges. Low margin, on the other hand, may be a double-edged sword. Because it is tiny, many traders take a bigger risk, and a sharp move in the other direction might not only wipe out the current margin, but also create desire for more. As a result, risk management is more critical in commodities than in stocks.
Unlike stocks, a trader just has to memorize one characteristic. The unit of a futures lot in stocks is always the number of shares. One lot of ABC, for example, will have 500 shares. In the case of commodities, however, the unit varies according to the product. It may be measured in kilos, tonnes, pounds, bushels, and barrels. The trader must understand the unit of the commodity he is dealing with.
Another element is the delivery of bought products. Even if there are normally few deliveries in derivatives markets throughout the globe, investors need to know that the underlying items may be delivered. Cash and delivery settlements are also possible on exchanges. Deliveries are often favored by customers or producers that have hedged their market position.
This raises the issue of who the commodities market's actors are. Hedgers, speculators, and arbitrageurs are the key participants in commodity markets. It is the final group of participants in the market that provide the most volume. Because global commodities are interrelated, experienced players may arbitrage and speculate effectively. When entering an arbitrage position, however, there is another aspect of currency hedging that must be considered. These days, most arbitrageurs are algorithmic, leaving very little possibility for an ordinary investor to profit.
Hedgers, on the other hand, are producers or consumers who take a market position to hedge their price risk. Thus, if a producer of copper believes futures prices are favorable, he would sell it in the market to lock in his price. If prices fall after he opens a position, he gains from the lower futures price, while he may make less money selling actual items in the cash market. Similarly, if the price rises, the hedger will lose in the futures market, but this loss will be offset when he sells the product on delivery in the cash market.
Another important actor in the commodities market is speculators. As previously said, the trader may take a position based on fundamentals or technical analysis if he is skilled in this area. Technical analysis works effectively in this market since it is liquid. Technical analysis techniques and tactics that are employed in equities markets may also be used in commodities.
Tracking fundamentals, on the other hand, is significantly simpler since demand-supply movements in commodity markets are little because they are all mature markets with fixed suppliers and consumers. Key events like the monsoon in the case of agricultural commodities and general economic development in the case of all other items may provide a comprehensive picture of the commodity. Because commodities are comparatively less volatile, some of the world's most successful traders have earned money in the market by trading commodities. In the commodities market, a rookie trader may learn the tricks of the trade considerably faster than in the equities market.
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