BAJAJ BROKING
July 11, 2024
7 mins read
The commodity market is a place to trade goods and services and works on the principle of demand and supply. Here is everything an investor needs to know about the commodity market and how to begin their trading journey.
To grasp the significance of the commodity market in India, one must first understand what the commodity market is and why it holds importance:
The commodity market plays a major role in the world economy.
Understanding the workings of the commodity market contributes greatly to designing important policy frameworks.
Such frameworks help contribute towards the growth of society by
stabilizing the effects of inflation
alleviating poverty
enhancing food production
mitigating the potential effects of climate change
supporting a country’s sustainable growth goals
Before we delve deeper into the commodity market definition, it is important to understand what the commodity market is:
The main purpose of a commodity market is to open the doors for exchanging physical goods for a country’s citizens.
Here, investors can trade several commodities like spices, precious metals, crude oil etc in the same country.
Investors interested in diversifying their investment portfolio can undertake investments in perishable and non-perishable products.
The Forward Markets Commissions, which is the regulatory body for the commodity market and futures in India, recently enabled 120 commodities to perform future trading.
Two types of commodity market have been divided according to the inherent nature of the commodities being traded in them:
Hard Commodities
The hard commodities market is a typical commodity market example and it includes natural resources that require mining or extraction.
Some of the examples of hard commodities include metal ores, oil reserves, etc.
Hard commodities are a crucial part of establishing the economic health of a country.
In the commodity market, being able to monitor the demand for such hard commodities helps gauge the future trajectory of an economy.
When it comes to hard commodities, supply and demand are quite predictable as the commodities themselves have a fixed nature.
For example, gold becomes extremely valuable when the market slows down since investors can use it as a hedge against inflation.
Soft Commodities
Soft commodities include products that need to be grown or reared and taken care of.
Some of the examples of soft commodities include agricultural produce, livestock, etc.
When it comes to the value of soft commodities in the market, there is more volatility assigned to them.
This is mainly because their price-setting process is largely reliant on multiple external factors like environmental conditions.
This is why economies based on agriculture are more affected during a crisis like climate change.
Many types of commodities are divided between the hard and soft commodities market. These include:
Agriculture Commodities: Agriculture commodities include
Grains like rice, wheat, maize,
Oil and oilseeds like soy seeds, castor, refined soy oil, etc.
Spices like jeera, pepper, etc
Pulses or dals like chana, urad, etc
Metals and materials: Aluminium, copper, zinc, tin etc. are included here.
Bulk commodities: Hard commodities like iron ore, coking coal, bauxite, steel etc. come under this category.
Precious metals: Under this category, hard commodities like gold, silver, platinum, etc are included.
Energy: Crude oil, natural gas, Brent crude, thermal coal, alternate energy.
Apart from knowing what is commodity market, it is important to know that the commodity market is mainly dependent on the rule of demand and supply. Here are the four stages that encompass the working of the commodity market:
The Primary Production
For the commodity market to set up trades, the production of commodities is the primary stage.
Primary producers include cultivators, animal rearers, miners, etc.
These are the agents who bring commodities to the market to trade.
The Secondary Production Stage
In this stage, raw materials are converted to finished products.
Some examples include cotton into yarn or cloth, wheat into flour, or rice into rice powder.
The Distribution Stage
After the production stages, the trading stage comes to the fore.
In this stage, traders, wholesalers and retailers sell their finished goods in the commodity market.
With the help of the commodity market, this stage becomes very smooth and seamless for them.
The Consumption Stage
After the finished products are sold by the traders, wholesalers and retailers, this is the last stage of the commodity market.
In this stage, the fold finished goods and services are used by individuals and institutions.
These individuals and institutions can use these products for personal use or use in further processing or production.
In commodity derivatives trading, both Futures and Options trading are included.
Commodity Futures:
The Commodity Futures instrument is a contract that enables the buying and selling of a commodity at a pre-determined time and price in the future.
Commodity Futures can be traded on the stock exchanges by retail investors, corporates, and hedgers.
Commodity Options:
Commodity options, like the nature of every option, are classified as calls and puts.
In a call option, a buyer is given the right but is not obligated to buy a particular quantity of an underlying asset at a pre-determined price before its expiry.
Commodity puts let traders sell a particular number of underlying assets, without the obligation to do so, at a fixed price before it expires.
There are many benefits of investing in commodities. This holds for both the hard commodities market and the soft commodities market. Some of the benefits are listed below:
Portfolio Diversification
When compared to stocks and bonds the commodity market does better during a rise in the market prices of goods.
Investing a percentage of one’s funds into the commodities market can help investors get better ROI even when the stock market is down, possibly offsetting potential losses from the latter.
A Hedge Against Inflation
Prices of commodities like gold usually rise faster over time even with the growing inflation.
This price graph supports linear growth in the long run, again offsetting any unexpected fluctuations.
Commodities are a great investment for investors looking for long-term returns.
Supports Margin Trading
Commodity brokers provide a lower margin to investors.
This helps trade on borrowed funds thus helping hedge investors in particular profit through the transactions.
Significant Returns
While hard commodities are more stable, soft commodities are subject to immense volatility, dependent on the eternal conditions.
If done right, traders can earn significant returns from these very volatile fluctuations.
Here is a step-by-step guide to starting commodity trading:
The Commodity Broker
Choosing the right commodity broker is very important.
There are two types of brokers under commodity trading - full-service brokers and discount brokers.
Full-service brokers have physical branches across the country and thus charge higher fees.
Discount brokers mainly operate virtually and this is why they have nominal charges.
When choosing a broker, investors need to look at all the costs involved.
Open a Demat and Trading Account
Without a Demat and trading account, one can't start trading online in the commodity market.
To open a Demat and trading account documents like your PAN card, Aadhar card, age proof, income proof, and bank account statement are needed.
With the right broker, investors can easily open these accounts virtually.
Before approving the demat and trading account every detail put down by the investor will be checked.
Knowing an investor’s income status is crucial for the broker to minimise risks.
The Initial Deposit
When all the demat and trading account formalities are completed, the broker will send the investor the account details.
The investor needs to make an initial deposit in the account.
This amount should ideally be 10% of the contract value of the commodity that investors want to trade.
Investors also need to remember to add funds that constitute the maintenance margin.
To understand what is commodity market it is important to understand its working and the benefits it provides a trader:
The classic commodity market definition would say that it is all about buying and selling raw materials and primary products.
Commodities are of two types; Soft and Hard Commodities.
Soft Commodities include agricultural goods and livestock.
Hard Commodities include commodities that can be extracted and mined which include metals, rubber, coins, and oil.
Of the most popular commodities, energy, wheat, gold, and coffee are some.
The commodity market runs on the principle of demand and supply.
Investors need to be aware of all the aspects of the commodity market to make profitable investments and steer clear of potential losses.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
For All Disclaimers Click Here: https://bit.ly/3Tcsfuc
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A question like what is commodity market might plague new investors but it is important to know that the main purpose of a commodity market is to open the doors for exchanging physical goods for a country’s citizens. Here, investors can trade several commodities like spices, precious metals, crude oil etc in the same country.
There are two different types of commodity market: Hard Commodities which Include natural resources that require mining or extraction and Soft Commodities which include products that need to be grown or reared and taken care of.
The commodity market works on the principle of demand and supply
In a spot market, spot commodities and other assets like currencies get traded for immediate delivery for cash. In a futures market, investors can choose to purchase a commodity at a later date.
The commodity market is mainly for individual retail traders and commercial entities
Some of the risks associated with commodity market trading include:
Price volatility of soft commodities
Leverage trading where higher returns exist but so do higher losses
Limited liquidity of the commodities because of trading at limited quantities
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