How to Trade in Commodities?
As you invest in shares, bonds, etc. you can invest in commodities as well. We will try to learn the concepts involved in commodity trading and how to invest in commodities in India. Trading in commodities is highly beneficial to producers, exporters, importers and others. They use commodities to hedge their risk against price fluctuations. MCX is the largest commodity exchange in India. The other prominent exchange is NCDEX (National Commodity and Derivatives Exchange).
Basics of commodity trading in India:
Why should one invest in commodities if he has invested in shares or bonds? You should not put all your hard earned money in just one asset. Diversification is one of the major benefits of investing in commodities. Investing in just a single asset is associated with high risks and hence investing in commodities is one of the best ways to mitigate risk. Before we deal about how to trade in commodities in India, let us have a brief idea about the types of commodities. Hard and soft are the 2 types while metals fall under hard commodities, agricultural produce fall under soft commodities. Few examples of hard commodities are gold, silver, copper, lead, etc. while soft commodities are corn, wheat, sugar, coffee, soybean, etc.
How to invest in commodity market:
Understanding the functioning of commodity market is very crucial as there are many factors that have an impact on the prices of commodities. Demand-supply forces result in the volatility of prices; the other major reasons for fluctuations in prices are government policies, currency prices, geopolitical concerns, etc. Let us concentrate on commodity trading basics now.
Knowing your risk capacity:
Before you begin to trade in commodities, first analyze how much risk you can afford to take. One should never put all his/her investment in just one commodity. Diversify your investments by investing in various assets, this will help you to compensate for the loss you incur in one asset with the gain in another asset. You should know the level of risk and reward before trading in commodities.
Use stop loss:
Trading in commodities is associated with risks as there are many factors that influence the price. One should always employ stop loss while trading in commodities otherwise he/she would face huge loss. Stop loss strategy helps you to stop your losses beyond a certain point. When you fix a stop loss level, your commodity gets sold or bought when the price of commodity reaches that level. This strategy helps you to minimize loss.
Have emotions under control:
Fear and greed are the major emotions that affect your logical decision making capabilities. One has to put emotions under check and take investment decisions with the support of solid research.
Reviewing is very crucial:
Reviewing your plans and strategies on a regular basis will help you in making the appropriate moves at the appropriate time. You should check whether your portfolio is in sync with the market developments.
The major influencing factor in case of commodity trading is seasonality. It is very essential to know how to invest in commodities as most of the commodities follow a pattern in price based on seasons. You should clearly understand when demand for a particular commodity increases and when it falls.
Take help of Technical analysis:
Trends in the movement of the price help one to predict the future price movement. Technical analysis plays a major role in forecasting the trend with which you can make the right moves.
Knowledge is the key. As the commodity market is highly volatile, you should always be in touch with whatever is happening in global and local commodity markets. One has to develop the habit of reading latest developments of the particular commodity in which he/ she wants to trade.
We will see some important points regarding how to trade in commodity market
1. Open a demat and trading account:
One needs a demat and trading account to execute trading in commodities. You can open an account with a SEBI registered broker. Anybody can trade online in commodities these days.
2. Margin amount:
You need to pay margin amount such as initial and maintenance margin. Initial margin usually is in the range of 5-10% of the contract value
3. Mark to market settlement:
Profit or loss you make is credited or debited from your account on a daily basis.
4. High leverage:
With a small amount, one gets the opportunity to participate in big deals.
Commodities can be traded as stocks, ETFs and as mutual funds. Let us read about these in detail.
Investing in commodity stocks:
If you are not willing to buy commodities directly, you can buy stocks of those companies that use commodities like oil companies, steel companies, etc.
Investing in mutual funds:
You can invest in mutual funds that invest in companies that deal with energy, agriculture and other commodities.
Investing in commodity futures contract:
By using commodities futures agreement, one agrees to buy or sell a particular commodity at a specific time in the future. How does one get profit? When the price of the commodity goes high, the person who bought the futures contract gets profit and when the price of the commodity decreases, the person who sold the futures contract gets profit.
Before you know how to trade commodities, firstly have clear financial goals and do extensive research or take the support of research experts. Returns are high in case of commodity trading and at the same time risk involved is also high. One should read a lot on how to start commodity trading in India and be well prepared. One can gradually become an expert in commodity trading with patience and research.