uTrade Algos
The stock and commodity markets are two systematic components of the larger financial system. The principal difference between the stock and commodity markets is:
I. When you trade in the stock market, you buy and sell stocks.
II. When you trade in the commodity markets, you buy and sell commodities.
Table of Contents
What Are Stocks and Commodities?
Both stocks and commodities represent ownership of something valuable. In the case of stocks, something valuable is a company. Conversely, when it comes to commodities, it’s raw, tangible goods.
Why Investors Trade Stocks and Commodities
Investors and traders buy and sell stocks and commodities on organized exchanges, primarily to make profits and grow their wealth. Investing in stocks has pros and cons, and so do commodities.
So if you’re thinking of trading in either market, you must know how the markets differ in ways other than the fact that in one market, you trade stocks, and in the other, you trade commodities.
What Is the Stock Market?
The stock market is for trading stocks, and stocks are like shares or units of a company. So, when you buy a company’s stock, you become an owner. In India, you can invest in the stocks of companies like Reliance Industries, TCS, HDFC Bank, ITC, etc. (not investment advice).
Stock Exchanges in India
The stock exchanges facilitate the trading of stocks, like the ones mentioned above. In India, we have two main stock exchanges:
- The NSE (National Stock Exchange)
- The BSE (Bombay Stock Exchange)
Commodity Market and Types of Commodities
The commodity market is a marketplace to trade commodities like copper, wheat, etc. Every commodity traded in India belongs to one of the following four categories.
- Bullion: gold and silver
- Base metals: copper, nickel, cobalt
- Energy: natural gas and crude oil
- Agri commodities: wheat, soybean, coffee
Commodity Exchanges In India
There are six commodity exchanges in India:
- Multi Commodity Exchange (MCX)
- Ace Derivatives Exchange (ACE)
- National Multi Commodity Exchange (NMCE)
- Indian Commodity Exchange (ICEX)
- National Commodity and Derivative Exchange (NCDEX)
- The Universal Commodity Exchange (UCX)
Stock Market vs. Commodity Market
| Stocks Markets | Commodity Markets |
| Trade company shares. For example, shares of HDFC Bank, Infosys, etc. | Trade commodities like gold, wheat, copper, etc. |
| Stocks exist in e-dematerialised form. | Commodities exist as physical objects (tangible objects). |
| To invest in this market, you need a Demat account to store your dematerialised shares. | To invest in this market, you require a commodity trading account. |
| Shares are traded on stock exchanges like the NSE and BSE. | Commodities are traded in the physical markets and on commodity exchanges like the MCX. |
| Trading Session: 9:30 AM to 3:30 PM. | Trading Session: Starts at 9:30 AM on weekdays but differs from commodity to commodity . |
| In the stock exchanges, you can trade in the cash and derivatives segments. | On the commodity exchanges, you only deal with derivatives. |
| In the stock market, stock derivatives are physically settled (stock delivery). | In the commodity markets, the derivatives are settled in cash. |
| Stock markets are for both long and short-term investors. | Commodity markets are for short-term investors. |
| You can stay invested in stock for years. | You are invested as long as the contract is active. Once the contract expires, you are no longer an investor. |
| Lower barrier to entry | Higher barrier to entry |
| Relatively less volatile | Very volatile |
Let’s expand on some of the latter points in the next section to help you understand which market is more suitable for you.
Investing in the Stock Market
Ways to Trade Stocks
Cash Segment: You pay cash upfront, and you get that much worth of stock. For example, if a company stock trades at ₹1000, and you wish to buy three shares/units, you pay ₹3000 (excluding brokerage fees).
Derivatives Segment: In the derivatives market, however, you trade futures and options contracts of an underlying asset, in this case, the stock.
- So, basically, when you trade derivatives like futures and options, you get into an agreement with a party to trade an underlying asset (the stock) at a mutually agreed price and quality on a future date.
- You do that by paying a portion of the entire transaction (for futures) or a fee contract fee (for options).
- One important thing to remember is that derivative contracts are traded in lots. This means that if you trade one lot of futures, you may be getting yourself to trade 500 shares/units of the stock.
Purpose of Investing in Stocks
If you see growth in the company, you may hold its stock for several years and see its value appreciate as the company grows. As the value of the stock appreciates, your wealth grows, and you may also receive income in the form of stock dividends. If you are a short-term trader or speculator, you may even buy and sell the stock on the same day to make quick profits.
Investing in the Commodity Markets
Ways to Trade Commodities
In India, you can either trade commodities in the
- Spot Market: A physical marketplace.
- Commodity Exchange: A regulated exchange, similar to the stock exchange, but facilitating commodity trading.
However, as a retail investor, what will you do with a kilogram of copper or a gallon of crude oil? You are not going to a physical market to buy a commodity; you are concerned with capitalising on the fluctuating price of the commodity. Therefore, as a retail investor, when you’re trading in the commodity markets, you’re trading over the commodity exchanges.
Commodity Derivatives
When you’re trading commodities over an exchange, you are buying or selling commodity derivatives—primarily futures contracts. They function similarly to stock derivatives in most ways yet differ in a few key ways.
Difference Between Stock and Commodity Derivatives
The main difference is that unlike stocks, when a commodity contract is settled, the settlement is done in cash. This means you’ll be getting or losing the cash equivalent, depending on whether you made a profit or loss; you won’t be dealing with the physical commodity. Because, again, you have no use for something like a gallon of crude oil.
Purpose for Investing in Commodities
So, unlike stocks, you can’t be an investor in commodities for several years; you are only invested in the commodity if you hold the contract; contracts may last for 1–3 months. Once the contract expires, you receive the cash equivalent and will no longer be invested in the commodity.
So, investors mainly invest in commodities to hedge against commodity prices or inflation, which can affect their stock portfolio.
Conclusion
- In the stock market, you invest in the stocks of companies, while in the commodity market, you invest in tangible commodities.
- Stocks can be long-term as well as short-term investments. Commodities are short-term investments.
- The commodity markets have a higher entry bar compared to stocks since commodity trading takes place through derivatives.