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How to trade in commodity?

Summary: The article talks about commodity trading, how it is different than trading in equity shares, and how an investor can invest in commodities.

Introduction

Commodities refer to essential items that are exchangeable and can be bought and sold. Be it food, metals, energy, or resources – commodities are fundamental for life, and investors can trade them on commodity exchanges similar to shares and bonds for profit.

What are the commodities that can be traded?

Commodity trade is divided into two significant categories

  1. Agricultural
  • Edible Oil: Soybean, Soy oil, Mustard Seed, Palm oil
  • Spices: Pepper, Turmeric, Jeera, Coriander
  • Pulses and Grains: Cotton, Mentha oil, Wheat Maize, Chana, Guar Seed

 

  1. Non-Agricultural
  • Precious Metals: Gold, Silver
  • Base Metals: Copper, Aluminum, Lead, Nickel, and Zinc
  • Energy: Crude oil and Natural gas

Where can one invest in Commodities?

Commodities can be traded on Multi-Commodity Exchange (MCX) or National Commodity and Derivatives Exchange (NCDEX) similar to how stocks are traded on the National Stock Exchange (NSE) or Bombay Stock Exchange (BSE). Forward Market Commission (FMC); the regulatory body of the commodities trading, has merged with the Securities and Exchange Board of India (SEBI) to facilitate the trades. Commodity exchanges require standard agreements to be followed to execute trades without the need for visual inspection of goods.

How to Invest in Commodities?

Commodities market could be a spot or in the form of derivatives contracts traded on exchange. Commodities are traded for immediate delivery in the spot market, whereas derivatives involve investing in financial instruments based on commodities traded.

A futures contract is the most straightforward way of investing in commodities. With a futures contract, investors reach an agreement to buy or sell standardized financial instruments or a specific quantity of the commodity at a pre-determined price and time in the future. Such a contract helps manufacturers dependent on such commodities hedge themselves against the risk involved with price fluctuations.

If traders do not want to invest in commodities directly but wish to profit from the price changes in the commodity markets, they can invest in Exchange Traded Funds (ETFs) of selected commodities. For example, Gold ETF tracks the prices of gold and allows investors to invest in that.

Benefits of investing in commodities:

Commodities have no co-relation with the rise and fall in the value of other financial assets. They are directly linked to the demand, supply, and worth of the underlying commodity. Investors are attracted to commodity markets to diversify their portfolio. However, investors must keep in mind that commodity markets are volatile and are affected by several economic and political factors.

Differences between Commodity Trading and Share Market

Buying and selling commodities are not the same as buying and selling shares. A few key factors to that differentiate the two include:

  • Perishability: The fundamental nature of the underlying asset in commodity trading is that the commodities are perishable, which means that if the commodity is not stored safely or perishes before the exchange, it may lose all its value. Unlike this; in shares, the underlying asset is intangible and can be shared as long as the company is functional.
  • Delivery: Commodity trade is heavily dependent on the physical delivery of the commodity, which is susceptible to much higher risk than the delivery of electronic stock certificates.
  • Volatility: Commodities are grown or mined in specific countries, and prices of such commodities are related to political relationships with these locations. These external factors make commodities highly volatile in comparison to stocks.

Conclusion

A Commodity is a unique investment vehicle that also serves as an alternative asset. Investors need to enter into future trading contracts to trade in commodities and can diversify their portfolio. However, there are several risks associated with commodity trading that investors should be cautious about before investing.

 

Disclaimer: The contents herein mentioned are solely for informational purpose and shall not be considered as an invitation or persuasion to trade or invest. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon.

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