uTrade Algos
If you are tracking the stock markets, you will observe several phenomena, like the relationship between stock prices and raw materials (commodities). For example, when crude oil prices shoot up, you will see a meaningful decline in the stock prices of those companies relying on crude for their daily operations. Even the best companies’ stock will be impacted.
In such a scenario, wouldn’t it be nice if you could bet on the price of crude oil increasing? The thing is, you could do that by trading in the commodity markets, yet many people don’t do that. So, let’s look at how you can profit from such situations by learning more about commodity trading.
Table of Contents
What Is the Commodity Market?
The commodity market is a marketplace to trade commodities that include raw materials like oil, copper, wheat, etc. Besides the obvious difference—in the stock markets, you trade stocks, and in the commodity markets, you trade commodities—both markets are similar in various other aspects. Both markets have their own trading exchanges, permit online trading, and let you trade financial instruments like derivatives.
Around the world, commodities are traded in physical markets or online over commodity exchanges. The latter function similarly to stock exchanges but facilitate commodity trading. So similar to how we have the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) for stock trading, in India, for commodity trading, we have:
- MCX (Multi Commodity Exchange)
- NMCE (National Multi Commodity Exchange)
- NCDEX (National Commodity and Derivatives Exchange)
What Can You Trade in the Commodity Market?
In India, you can trade four categories of commodities on exchanges like the MCX: base metals, energy, agri commodities, and bullion.
- Base metals: copper, lead, nickel, aluminium, etc.
- Energy: crude oil and natural gas
- Agri commodities: cotton, kapas, rubber, palm, oil, etc.
- Bullion: gold and silver
The prices of commodities are influenced by a variety of factors, including supply and demand, geopolitical and economic events, weather patterns, etc. Moreover, these commodities are traded in bulk quantities.
How Do You Trade on the Commodity Exchange?
As a retail investor, you need a commodity trading account to trade commodities on exchanges like the MCX. You can do that by approaching an authorised commodity broker. Consider looking up different commodity brokers, researching, and choosing one, and you should be able to open the account online.
If you already have a trading account for stocks, you may simply have to activate the commodity trading segment. That shouldn’t be a hassle, and you should be able to do it from within your stock trading app itself if your existing broker provides commodity trading services.
When Can You Trade Commodities?
In India, the MCX opens at 9:00 AM and closes at 11:00/11:30 PM on weekdays. It remains closed on Saturdays, Sundays, and exchange declared holidays. However, since each commodity category is different, the trading sessions for a specific commodity may vary based on which category it falls into. For example, internationally linked agri commodities can be traded from 5:00 PM to 9:00/9:30 PM on weekdays.
How Does Commodity Trading Work?
So far, it was simple; now, we have arrived at the part that makes commodity trading complex. If you wish to trade commodities, you must have more than a basic understanding of derivative contracts, i.e., futures and options. That is because commodity trading on the MCX is primarily carried out through futures contracts.
Commodity Futures
In commodity trading, futures contracts state an agreement between a buyer and seller to trade a commodity at a specific price on a future date. Traders take a long position if they anticipate an increase in commodity value, while they take a short position if they expect the price to decrease.
To take positions in a futures contract, you do not have to pay the entire contract value but only a portion of it. You pay the entire amount if you still hold the contract on the expiry date, which is the predetermined future date.
Furthermore, on the expiration date, the futures contract—your profit or loss—is settled in cash. That means you don’t have to deliver or take delivery of the commodity. So, if you buy 1 barrel of crude for ₹5,000, and on the expiry, the price is ₹6,000, you’ll get your principal amount and the profit in cash; no one will deliver a barrel of crude to your home.
Futures Entry Barrier
So, what’s the catch here? Things seem fine so far. Something to keep in mind is that commodities are traded in bulk. That is because, unlike stocks that exist in a dematerialised form, commodities do not—or cannot—exist in an electronic form since they are physical, tangible goods. That is possibly the primary reason commodity trading occurs on exchanges via derivative instruments.
Unlike stocks, you have no online cash markets and can’t trade a single unit of a commodity; you have to trade an entire lot of units. In other words, you cannot buy or sell 1 kg of copper; you must trade the fixed lot size, which may involve 100 kg of copper.
Therefore, even when you are paying only a portion of the entire value of the contract, the amount is still significant. However, commodity options are becoming increasingly popular with each passing day. Options have lower entry barriers to taking a position, but exercising the contract will involve significant amounts.
Should You Trade Commodities?
Commodity trading has a higher barrier to entry into stock trading and is potentially a riskier avenue since you can only trade derivatives. However, if you have the capital, commodity trading can help you diversify your portfolio and capitalise on raw material inflation. So, smart investors may use commodities to hedge their investment portfolio. That said, it is still necessary that you absolutely understand these derivatives contracts thoroughly.
Conclusion
Commodity trading involves the trading of raw materials and tangible goods like oil, copper, gold, wheat, etc. In India, the MCX is the main commodity exchange. To trade on the exchange, you will need a commodity trading account.
Commodity trading occurs through derivative contracts, so understanding how these contracts work is essential to trade commodities. The inclusion of commodities in your portfolio can help with portfolio diversification and hedging.