Overview

What is Commodity Trading?

Commodity trading is purchasing or selling raw materials or primary products, such as metals and agricultural products. In contrast to financial markets with securities such as stocks and bonds, commodity trading specialises in real commodities. The two major types of commodities include:

• 1. Hard commodities: gold, oil, and natural gas
• 2. Soft commodities: wheat, coffee, and sugar

A combination of supply and demand, geopolitics, weather, and economic data controls these markets.

Trading in commodities can be done directly by buying and selling commodities, which generally takes place in spot markets, where commodity-based buying and selling happens with immediate delivery, or by means of futures markets, where buyers and sellers commit to trading a commodity at an agreed-upon price for delivery at a future date. The latter is more popular due to its potential for risk management and speculative gains.

How to Trade in the Commodity Market

Here are the steps to begin your commodity trading journey:

• Select Your Market: Decide to trade either in the spot market or through futures contracts.
• Selecting the Best Trading Site: After appropriate research, choose a reputable broker or trading site that is registered with bodies like the Securities and Exchange Board of India (SEBI). IIFL Capital Services Limited is a reliable choice.
• Understanding the Specifications of the Contract: With every commodity contract comes a set of terms. These include size, date of expiry, and quality specifications. Understand these to avoid surprise instances.
• Analysis and Strategy: Perform technical and fundamental analysis before devising a strategy.
• Risk Management: Utilise stop-loss orders and limit orders to minimise the possibility of potential losses and maximise potential gains.

The Process of Commodity Trading in India

Follow these steps to begin commodity trading in India:

• Open a Trading Account: Find a registered broker offering commodity trading services to set up your trading and Demat account with them.
• Complete KYC Formalities: Submit required KYC documents, such as your PAN card and bank account details.
• Activate the Commodity Segment: You should activate the commodity trading segment once you have completed the KYC verification. This may take a few hours to a couple of days.
• Deposit Margin Money: You will be required to deposit the margin amount in your trading account in order to start trading. The margin varies from commodity to commodity and broker to broker.
• Choose Your Commodities and Execute Trades: Once you have analysed your commodities, you can now go ahead and trade. Place an order on your broker's trading platform, monitor the trends in the market, and change your strategy according to the movement in the market.

What are the Benefits & Risks Associated with Commodity Trading?

The benefits include:

• Diversification: As commodity trading allows investors to diversify beyond stocks and bonds, it enables them to place their money in more promising assets.
• Hedge Against Inflation: Historically, commodities have performed well in times of inflation. Commodities can also provide a hedge against rising consumer prices.
• High Liquidity: Major commodities, including gold, oil, and agricultural products, have high liquidity, which makes them easy to buy and sell.
• Profit Potential: Price volatilities in commodities allow for a large profit margin to be gained in the short-term.

The risks include:

• Highly Volatile Prices: The prices are highly sensitive due to conditions such as geopolitical tensions and supply chain disruptions.
• Leverage Risks: Trading on margin has the potential to multiply returns and benefits but can also mean severe losses.
• Market Know-How Needed: Very detailed knowledge of the market trends and what affects them is required for successful commodity trading. Amateur traders have really high learning curves.
• Regulatory Risks: Changes in government policies or the appearance of any policy that is against international trade agreements can hugely impact commodity prices.

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