Commodity Trading: Types and Benefits

Commodity trading involves buying and selling goods such as metals, energy, and agricultural products. It can be done through futures contracts on exchanges, allowing traders to speculate on price movements or hedge against them. Through this article, you will gain insights on commodity trading. There are different types of commodities that are exchanged in the market.

Table of Content

• Types of Commodities
• Methods
• Benefits of Trading in Commodities

A commodity is a basic good that is interchangeable with goods of the same type. Grain, oil, natural gas, beef and gold are some examples of commodities. These help in diversifying the portfolio beyond traditional securities. Those who wanted to trade in commodities can invest through futures contracts, exchange-traded funds options funds. Commodities exchange refer to both physical places where trading takes place. It also refers to a legal entity that has been formed to enforce trading rules of standardized commodity contracts and investment products. 

Types of Commodities

The commodity market is driven by the basic principle of supply and demand. There are different types of commodities that are traded into 4 categories including energy, livestock and meat, agriculture and metal.

Metals 

Commodities in metal include silver, platinum, copper and gold. Investors usually invest in precious metals since it is reliable and has conveyable value.

Energy

Any shift in the production by the Organization of the Petroleum Exporting Countries and new technological advances in the alternative energy sources impact the market prices for commodities in the energy sector. 

Agriculture

Agriculture commodities along with limited agricultural supply provide opportunities to profit from the increased rising agricultural commodity prices. This can be a volatile sector since most produce is season based. 

Livestock and Meat 

Such commodities include pork bellies, live cattle, lean hogs and feeder cattle.

Types of Commodity Exchanges

You should have knowledge of trading in commodity exchanges. Commodity exchange is a regulated market where commodity trading takes place. Traders can choose physical delivery of commodities or who can deal in Futures contracts. A futures contract is an agreement to trade a fixed quantity of the commodity at a pre-decided price and within the expiry date. Following are the various national commodity exchanges in India:

• National Multi Commodity Exchange
• Indian Commodity Exchange
• Universal Commodity Exchange, Limited
• National Commodity and Derivatives Exchange of India
• Multi Commodity Exchange of India, also known as MCX
• Ace Derivatives and Commodity Exchange Limited

Methods of Commodity Trading

There are different methods for trading commodities. These methods have advantages and disadvantages.

Commodities Trading Futures

You can trade commodities by buying and selling contracts on the futures exchange. It is an agreement with another investor based on the future prices of a commodity. You will have to set up an account with a speciality brokerage account that offers these types of trades.

Physical Commodity Purchases

Whenever you trade futures contracts, you are not actually physically accepting millions of barrels of oil or live cattle. It is betting on price changes only. In the case of precious metals or jewellery, investors can take possession of physical goods.

Stocks

Investors who want to enter the market for a particular commodity can invest in commodity-related stocks. Stocks are less volatile in comparison with future contracts. Investors can easily buy, hold, track and trade in stocks. You can effectively narrow down investments in a particular sector. Investors can also purchase options on stocks that only require small investments instead of buying the stock directly.

Benefits of Trading in Commodity Exchanges

1. Potential Returns

Several factors affect the prices of individual commodities such as supply and demand, inflation and economy. Due to massive global infrastructure projects, demand has increased in the global infrastructure projects that impact commodity prices. A positive impact on the company stocks affects commodity prices.

2. Potential Hedge Against Inflation

Inflation can cause a hike in prices for commodities. During high inflation, commodities show strong performance, commodities are more volatile in comparison with other types of investments.

3. Diversified Investment Portfolio

A diversified investment portfolio refers to an ideal asset allocation plan. Commodities help in diversifying the investment portfolio. An investor can invest in raw materials in case you want to invest in stocks and bonds.

4. Transparency in the Process

Trading is a transparent process in commodity futures that allow a fair price that is controlled by large scale participation. It reflects different perspectives of a large number of people who deal with the commodity.

5. Profitable Returns

Commodities become riskier in the form of investments if the liquidy is high. This means that companies can experience both huge profits and heavy losses. 

6. Cushioning against market fluctuations

Money requirement to buy commodity goods if the rupee becomes less valuable. During inflation, investors sell off stocks and bonds for investment in commodities. This leads to an increase in the prices of commodity goods. You can only benefit from commodities that act as a hedge against market risks.

7. Trading on Lower Margin

Traders can deposit 5 to 10% of the total contract value as a margin with the broker. This is less in comparison with other asset classes. Low margins allow individuals to invest and take larger positions at lesser capitals.