Trading in commodities: types and advantages | Motilal Oswal

Trading in commodities

The standardised resources or raw materials that are used in the manufacturing of finished products are commodities. In terms of commodity trading, they are raw materials having an intrinsic value. These are unrefined resources which are used in the process of making refined goods that are sold and used by consumers in their daily lives. The quality of certain commodities may vary, but they are uniform based on some criteria in any class of a particular commodity. 

In the market, there are two kinds of commodities for commodities trading. They are broadly categorised as hard commodities and soft commodities. Hard commodities are those which are used for inputs to produce other goods and services. These may constitute minerals and metals. Soft commodities are made use of primarily for the purpose of initial consumption, and these include wheat and rice. 

Commodities Trading and Commodity Markets

Commodities can be traded on the exchanges for commodities or in the spot markets. If they are traded on any of the commodity exchanges, they have to meet some minimum standards of exchanges for trading to take place. Traders are able to make purchases of commodities through contracts of a derivative (futures and options) nature, or buy in the spot markets. You may have already had to open a demat account to trade in stock, but now you should turn your view to commodities. They offer a great way to diversify a financial portfolio. Since the direction of prices in the commodities markets shift in sharp contrast with stock prices, you can partake in online commodity trading when the stock markets display volatility. 

The Market of Commodities

Resembling other markets, commodities markets are either virtual or physical spaces in which any interested investors trade in commodities. These are generally raw products which are traded in currently or at a future time (as with futures and options contracts). Prices of commodities, as history tells us, are largely dictated by demand and supply variables, which in turn may be influenced by factors of a geopolitical nature. If you wish to partake in commodities trading, you have to do some background work based on the commodity or commodities you want to trade, just like you have to do some background checking if you invest in any company offering an upcoming IPO subscription. This brings us to the types of commodities you can trade in and their implications for price changes. 

Commodity Types

In the world today, there exist 50 main commodity markets. These trade in excess of 100 commodities. Broadly speaking, traders and investors can invest in four primary categories of commodities:

  • Metals - Metals are used for industrial purposes and for the manufacture of consumer durables and many other products worldwide. Nickel, aluminium and copper are used in manufacturing and construction, while metals such as gold, silver and platinum are considered precious. 
  • Energy Commodities - These largely constitute raw materials used in industry and households, and comprise of oils and natural gas. There are other commodities in the energy class like ethanol, electricity, coal and uranium too. 
  • Agricultural Commodities - While you engage in online commodity trading, you may want to trade in agricultural commodities which are always in high demand. These constitute grains, oilseeds, sugar, pulses, cocoa, livestock, and more. 
  • Environmental Commodities - This is the category that has to do with white certificates, renewable energy and any commodities related to environmental wellbeing. 

On an international playing field, the commodities which are the most traded are Brent oil, crude oil, silver and gold, natural gas, corn, coffee, wheat and cotton. 

The MCX

The MCX in the Indian context of commodities trading stands for the Multi Commodity Exchange of India. Traders and investors can trade commodities like agricultural commodities (cotton, palm oil, castor seeds, etc.), energy commodities (crude oil and natural gas), base metals (brass, zinc, aluminium, copper, nickel, etc.), and bullion (silver and gold) on this exchange. 

On the National Commodity and Derivatives Exchange (NCDEX) in India, traders may also trade soft commodities like sugar, and other commodities like pepper, castor seed, refined soy oil, etc. 

The Advantages of Commodity Trading

In India, trading in commodities is regulated by the Securities and Exchange Board of India or SEBI. The commodity exchanges work according to rules and regulations under its watchful eye. This brings in a lot of transparency in trading activity and draws many investors. This is just one among key advantages of commodity trading and more are explained below: 

  • A Safeguard Against “Black Swan Events” - During climbing inflation periods, stock markets tend to plunge as this makes it costly for companies to borrow and profits are adversely impacted. When this happens, commodities trading is at its best as the prices of commodities increase. This makes commodities trading profitable at such times. 
  • High Leverage Provision - Traders get to enhance their profit-making potential as vital positions can be taken by margin trading. What this translates to is that even with a price rise that is insignificant, the potential for profit can rise substantially. The minimal margin required may vary from one commodity to the next, but it still works out to less than margins that are required for investments in equity. 
  • Portfolio Diversification - When you want to hedge your investments, you can get some protection from the commodity markets and your investment when stock prices fall. In this manner, you diversify your portfolio and balance risk and reward. 
  • Transparent Transactions - Online commodity trading in the commodities markets is highly rule-driven. Security measures are good and you get transparency in all your trading transactions without any manipulation risk. With participation at a board scale, there is the aspect of fair pricing in the commodity markets, an ethical place for trading. 

Extend Your Investment

Conventionally, investing in stocks has become something of a boring investment activity for many traders. Although the stock markets see the most investment activity globally, those who already have a satisfactory stock portfolio can venture into commodities trading. It is easy to do online as you just have to open a demat account along with a linked trading account. As with any investing, you will need a linked bank account for the seamless flow of capital too. While you are in the process of diversification, you may want to check out any upcoming IPO investment too. 

 

Related Articles: How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account | Factors to Consider When Opening a Demat Account | 10 Points to Remember When Operating your Demat Account | Types Of Demat Account & Trading Account | Understanding the economics of Nickel trading on the MCX | MCX Meaning - Learn What is MCX, Its Advantages, and More

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