Commodities are a basic and essential part of everyday life for everyone. All of us need one or the other kind of commodity to live and survive. To eat, we would need agricultural and livestock commodities like grains, meat, etc.
Most of us cannot start our days without a good cup of coffee. Therefore, commodities exist as a crucial part of our daily lives. A commodity is any good that can be exchanged for other goods.
For sophisticated investors and traders, Commodity trading can prove to be one of the fairest ways to diversify the portfolio and mitigate risk concerning other securities and instruments in the league.
In the past years, commodity trading was a complicated affair as it required a lot of capital, funds, efforts, and time. Only professionals and experts were able to make it to the commodities.
Today, commodity trading has become more accessible to all kinds of traders and investors. If you’re too interested in commodity trading, read this detailed guide for beginners.
What Is The Commodity Market?
The market that trades in raw materials or primary economic sectors such as sugar, soy, fruits, cattle hogs, natural oil, and precious metals like gold and silver is called the commodity market.
Therefore, traders can generate a high amount of profits by diversifying their investment portfolio through investing in commodities.
In addition, commodities are considered a good hedge against inflation because their prices tend to rise during periods of high inflation.
The commodity market is gaining mainstream adoption these days because it allows you to hedge against the potential financial loss that can be incurred due to stock trading. This is because of the opposite price movement of commodities against stocks.
You can unlock ample opportunities while trading in the commodity market by getting exposure to commodities via commodity futures contracts and investing in small to large-cap companies which are related to the commodities somehow.
- National Multi Commodity Exchange of India Ltd (NMCE)
- National Commodity and Derivative Exchange (NCDEX)
- Multi Commodity Exchange of India (MCX)
What Are The Four Types Of Commodities?
The four major types of physical commodities that are traded frequently include precious metals, energy, livestock & meat, agriculture and industrial metals such as Iron ore, Zinc. Here’s a detailed overview of these commodities:
Silver, Gold, Copper, and Platinum are included in the metal category of commodities. During the bearish and highly volatile market conditions, many investors can turn up to invest in precious metals.
Most of the time, traders and investors prefer gold. The reason is its trustworthy status and convertible value. An investor also performs hedging functions through such metals during extreme inflation or currency devaluation.
Livestock and Meat:
Another type of commodity is livestock and meat. The traded commodities include feeder and live cattle, and pork bellies. You can easily trade livestock and meat through futures, and CFDs.
Agricultural commodities include a wide range of products like cocoa, wheat, soybeans, maize, rice, cotton, and sugar. Trading agrarian commodities can prove to be highly volatile during months of weather-related changes.
In addition, the limited supply of agricultural products and high population growth can serve as significant factors for traders to go with such commodities.
Energy commodities include heating oil, natural gas, coal, crude oil, and gasoline. Due to the global demand, the oil supply has decreased. This has kindled high oil prices in the market.
Simultaneously, alternative energy sources like solar energy, biofuel, and wind power can witness a rise in demand. Such energy sources aim to substitute crude oil as the core source of energy.
How To Trade Commodities?
There are many different ways through which traders can trade commodities in their portfolios.
Commodity Trading Through Futures:
One subtle way to trade and invest in commodities is through futures contracts. A futures contract is a legal contract to exchange a particular commodity at a current market price at a fixed time in the future.
The buyer now has an obligation to receive the commodity in the picture as and when the contract reaches the expiration date. To determine the value of a futures contract, it’s essential to understand how interest rates affect its price.
The seller, therefore, has the responsibility to provide the commodity to the buyer on that date. Futures contracts can be exchanged for every kind of commodity in the market.
On the other hand, a trader will owe a commodity futures trading commission each time when they open or close a position.
Several advantages associated with futures trading include:
- They lead to a more precise and more effortless analysis because it is an unmixed take on the underlying commodity.
- It is typically easy to carry both short and long trading positions through futures contracts.
- There is a vast potential for high profit when investing directly in the futures markets.
Commodity Trading Through Stocks:
The indirect way to play in the commodity market is by investing and trading the stocks of companies that produce or deal in the particular commodities you are interested in.
For example, if you are interested in agricultural commodities like grain, you can invest in a company that deals in these products through stockbrokers regulated by the National Stock Exchange in India.
Stocks tend to be less volatile and are a bit immune to abrupt price swings. At the same time, they are easiest to exchange, buy and hold.
One can easily focus and narrow down the investments to a specific category. But one must do adequate research about companies one is planning to put money in.
The drawback is that stocks are not an unmixed take on the commodity. The price of a commodity stock can also be impacted by factors that include the company’s management or leadership.
One can also invest in options through stocks. Options work similarly to futures contracts. It necessitates smaller amounts than buying stocks directly.
Commodity Trading Through ETFs:
Trade or Investing in commodities through Exchange Traded funds is another way to enter the commodities markets. The ETFs work and function just like stocks and allow traders to benefit from the market prices fluctuation without actually investing in futures or stocks.
The commodity ETF track the price of a clan of commodities by using futures. The Exchange Traded Funds allow traders to speculate on the price movements of a group of commodities.
In addition, there are no or very minimal management charges associated with ETFs. But ETFs are not available for all types of commodities.
Other Ways To Trade In Commodities:
If you don’t want to get involved in commodity trading directly, you can invest in stocks of firms that use commodities, such as oil corporations (Total SE, BP PLC, Chevron Corp., and so on).
A commodities futures agreement commits a buyer or seller to acquire or sell a specified commodity at a future date. In addition, you can trade commodities through commodity pools and managed futures or through index funds and bonds.
You can invest in a mutual fund that invests in energy, agriculture, and other commodity-related companies. Another option for commodity traders is investing in steel companies like Nippon steel corp., POSCO, Ansteel Group, etc., and other industries.
So how does one make money? The person who bought the futures contract makes money when the price of the commodity rises, and the person who sold the futures contract makes money when the price of the commodity falls.
How to Start Commodity Trading?
Before starting to trade commodities, it is necessary for a trader to understand the market conditions, and factors that cause the price changes.
Here’s a step-by-step guide to starting commodity trading:
Choose A Reliable Broker:
The first step of trading is to choose a good and reputed brokerage platform. Always trust a broker which is well regulated by a global regulatory authority.
In addition, other factors to consider while choosing a good broker include fees and charges, platform services, and the range of products it is offering.
Open A Commodity Trading Account:
Now that you have chosen a good broker, it’s time for the account opening process. A trading and Demat account is a necessary part of your trading journey as it provides a pathway between traders and the financial market.
Most of the online brokers nowadays allow you to open a free trading and free Demat account. Just fill out the application form including your name, email id, and mobile number to create a commodity trading account.
Alternately, you can also make use of a free demo account if you’re a beginner trader. Practice on a demo account and switch to a live trading account when you think you’ve got enough knowledge.
Select A Commodity:
After creating an account, it’s time for the real thing. Select a commodity that you want to buy or sell, then click on Trade. Now, enter the number or amount of units you want to trade.
Set The Parameters:
After choosing the number of units of commodities, set some of the important parameters such as Stop Loss and Take Profit, Leverage, margin, etc. Using a good strategy, move forward to an open position.
Open A Position:
Now, select the ‘Open Trade’ button to start trading commodities. After placing an order, it is vital to monitor your position regularly.
Commodity trading can prove to be an excellent way to diversify the portfolio and reduce the risks beyond traditional securities. This type of trading is a risky affair because the principles of demand and supply are affected by uncertain events and natural calamities.
But if done diligently and correctly, commodities trading can lead to huge profits. If you are eyeing for an online broker to facilitate Bitcoin trading or other trades, we would recommend ABInvesting.
Apart from commodities, the broker provides trade in a wide range of securities like forex, stocks, indices, metals, and cryptocurrencies.
Is Commodity Trading Good For Beginners?
Yes, it is great for beginner traders as it is the easiest and less complex form of trading. You can trade commodities through CFDs too.
Is Commodity Trading Better Than Stock Trading?
Trading in commodity markets is highly volatile in comparison to stock trading. Some consider it to be the best form of trading, while others still prefer the stock market.
Can You Get Rich Trading Commodities?
Yes, commodity trading offers ample opportunities to traders to earn high profits. But to get rich and successful, you’ll need to understand the commodity trading basics.
What Is The Most Profitable Commodity?
Gold, Crude Oil, and Natural Gas are considered the most profitable commodities.
Is Commodity Trading Safe In India?
Yes, it is totally safe and regulated in India. All you need is a broker to start commodity trading in India. On the other hand, commodities are traded through three major commodity exchanges in India including the Multi Commodity Exchange of India Ltd (MCX).