In this consumer era, we don’t have to tell you what a commodity is. It is a part and parcel of our daily lives. So, let us try and understand what commodity trading is straight away.
What is commodity trading?
Commodity trading is the buying and selling of raw materials or products of the primary economic sector in the market. These primary sector products are classified into four broader categories, namely,
- Metal
- Energy
- Livestock & meat
- Agricultural products
Commodities trading is a way to diversify the portfolio of investors beyond traditional security trading.
You know how the Russia-Ukraine war impacted the oil and pulse rate all over the world. Weather, pandemics, war, and many such unpredictable events have a direct impact on the price of commodities. Hence, it is more volatile than the securities market.
Commodities Trading in India
Commodities trading occurs similar to any other trading. In India, there are two major commodity exchanges: the Multi Commodity Exchange of India (MCX) and the National Commodity and Derivatives Exchange (NCDEX).
Similar to securities exchanges, the investor needs to register with a commodity broker who is a member of the commodity exchange and obtain a client code from the exchange. Traders place orders through brokers in the same way securities transactions are happening.
However, in India, Most commodity trading happens through futures contracts. These contracts specify the quantity, quality, and delivery details of the commodity. Futures contracts allow traders to speculate on price movements without actually owning the physical commodity.
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The Do’s of Commodity Trading
Research and Education
Commodity trading, like any other trading, requires thorough research. Before jumping into the market, take ample amounts of time to learn about the commodity you are planning to trade. Stay informed about the global economic events, trends, and geopolitical events that will impact commodity prices. Constant learning is the key to success in commodity trading.
Risk Management
Risk is an inherent possibility in every trading activity. Setting a clearly defined risk tolerance level is crucial for the long-term success of commodity trading. Possible actions you can take to reduce risk are:
- Set up stop-loss orders to reduce risk.
- Diversify your portfolio to distribute your risk across different commodities.
- Create your portfolio with the aim of reducing the impact of adverse price movements in a single market.
Have a Comprehensive Commodity Trading Plan
Develop a clear training route that outlines your goals, strategies, and risk management techniques. Plan the criteria for assessing the market condition and entry and exit points at the beginning itself. The blueprint of your trading journey at hand from the beginning will make you more disciplined and help you avoid impulsive decisions.
Stay Informed About Market Fundamentals
Commodity prices are highly dependent on supply and demand, which in turn is affected by weather conditions, geopolitical events, etc. So, constantly update about the economic indicators and their underlying causes to anticipate the price movements So that you can plan your trading accordingly.
Use Technical Analysis
Make use of technical analysis tools to determine important trading decisions like entry points and exit points. Technical analysis can provide more insights into the market trends and help you to make more informed decisions.
Utilize Stop-loss orders
Executing stop-loss orders is a judicious risk management strategy. Stop-lose orders help you avoid potential losses by automatically selling your position at a predetermined price level. Set up and adjust your stop-loss orders according to the market condition.
Stay Liquid
Liquidity enhances the efficiency of trading. When it comes to commodity trading, liquidity is essential to manage risk. To easily buy and sell commodities without affecting their prices, focus should be placed on commodities that are actively traded with sufficient training volume.
Continuous Monitoring and Adaptation
The market, especially the commodity market, is highly dynamic. So, constant monitoring of the trends and events that would impact the price is required to adjust your trading strategy accordingly.
Don’ts of Commodity Trading
Ignoring Market Trends
As mentioned above, keeping track of the market trend is crucial to managing risk and avoiding huge losses. So entering commodity trading and avoiding the market trend analysis will cost you heavily.
Speculating without Research
Speculation in trading is not following your gut feelings and rumors. Speculation and your trading strategy should be based on a deep analysis of market fundamentals and trends.
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Overleveraging
Leveraging can earn profit and this has made overleveraging a trend and pitfall in commodity trading. It can magnify the losses as much as bringing profit. So don’t overdo it and wipe out your capital in a volatile market condition.
Ignoring Global Events
In commodity trading, you are buying and selling primary sector products. So you need to be aware of the global events that could impact the demand and supply of the commodity in the market. Unlike securities trading, where the reflection of wars and climate change may take time to reflect in the market, commodities as an important component of our day-to-day life are more vulnerable.
Lack of Diversification
If you build your portfolio around a specific commodity, a setback in that specific market will cause you a huge loss. For example, suppose you have identified oil as a lucrative commodity with huge potential. You bought assets around oil-related commodities. You have futures contracts on crude oil, options tied to the oil market, shares in oil companies, etc. Then comes the Russia-Ukrainian war, a huge geopolitical setback in oil trading. Your entire portfolio is going to be impacted by this event. On the other hand, if you distributed your portfolio among different commodity groups, you could have balanced the loss in the oil share with another commodity with a possible profit.
Neglecting Risk Reward Ratio
You need to access the risk-reward ratio related to each trade before entering the commodity market. Avoid trades where the potential reward does not justify the risk involved in it. Get ready to take risks only if the reward is worthy of doing it.
Unaware of Market Regulations
SEBI regulates the commodity market in India. Hence, the commodity market is subject to regulations set by SEBI and the central government. If you fail to comply with the regulations you may have to face legal action and financial penalties.
The commodity market is an exciting opportunity for those who are ready to learn and discipline themselves. It is a gold mine if you have good strategy, execution, and awareness of the do’s and don’ts.
FAQs About Commodity Trading
What is commodity trading?
Commodity trading is the buying and selling of physical goods or derivatives contracts representing ownership of these goods. Commodities can include primary sector products such as agricultural products, metals, and energy resources.
Can I trade commodities without physically owning them?
Yes. Commodity traders can engage in derivative trading such as futures and options contracts. In derivative trading, you can speculate the price of the underlying assets without owning them.
What are the factors influencing commodity prices?
Commodity prices can be impacted by supply and demand variations, geopolitical events, currency fluctuations, weather changes, etc.
What are the major commodity trading exchanges in India?
Multi Commodity Exchange of India (MCX)
National Commodity and Derivatives Exchange (NCDEX)
National Multi Commodity Exchange (NMCE)
Indian Commodity Exchange (ICEX)
Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.
