By Aditya Rangroo
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How to trade in commodities: A beginner’s guide

Commodities provide investors with an additional means of diversifying their portfolios outside of standard securities
How to trade in commodities: A beginner’s guide
Soft commodities are primarily used for initial consumption, whereas hard commodities are often used as resources to manufacture other items and deliver services

Trading in commodities is quite popular when it comes to exploring avenues of earning money. Apart from trading in the equities market, commodities trading can also provide investors with good gains in a short span of time.

However, investors who want to begin trading in commodities should keep in mind that, in contrast to trading stocks or corporate bonds, the option here is to purchase and sell real commodities, like gold or pulses, and make money from it.

What are commodties

Market capitalization is important because it allows potential investors to understand the true value of companies and the size of one company in relation to another. It helps investors to predict the future performance of the stock of a company because it reflects what the market is willing to pay for the stock.

With the knowledge of the market caps of various companies, investors are able to make better informed decisions about the types of stocks they would want in their portfolios, in accordance with their investment plans. Over a long enough period of time, large-cap, mid-cap, as well as small-cap stocks have the potential to lead the markets due to being differently affected by changes in the economy. It is for this reason that investors prefer to have a diverse portfolio consisting of a well balanced mix of these three types of stocks.

What is commodity trading

Raw resources that are regularly traded in the market, such as food (rice, grains), energy (crude oil, petrol), metal (gold, silver), and other similar products, are referred to as commodities. When individuals trade these commodities on a commodities market, that is known as commodity trading. You need a demat account in order to trade these commodities on the exchange.

Types of commodities

Commodities have a fundamental value given that they are essentially the raw materials used to manufacture refined items in the economic market. On commodity exchanges, traders get together to purchase and sell commodities like metals, agricultural products and petroleum. Commodities provide investors with an additional means of diversifying their portfolios outside of standard securities. Some investors rely on gains from commodities during times of market volatility since the prices of commodities typically fluctuate in the opposite direction of equities.

The commodities market is divided into two categories: hard commodities and soft commodities. Soft commodities are primarily used for initial consumption, whereas hard commodities are often used as resources to manufacture other items and deliver services. Hard commodities are materials like metals and minerals; softer commodities are crops like wheat and rice.

Commodities are often categorised as:

  • Agriculture: Cereals and pulses, including wheat, maize and rice
  • Precious metals: Platinum, palladium, gold and silver
  • Energy: Crude oil, both renewable and non-renewable energy, etc
  • Minerals and metals: Soda ash, iron ore and aluminium, among others
  • Services: Mining, energy and other services

How to trade in commodities

Trading in commodities also requires a demat account, just like trading in stocks does. You may create an account with any brokerage, but it’s important to choose a reputable company that gives you important trading advice. To navigate the complexity of the commodities market, you need the right information and direction.

Choosing a brokerage that has competitive rates is equally important. Selecting a broker that charges a high fee may reduce your profits. Assess the services the broker provides on its platform. It is in your best advantage to choose a full-service broker since they have a team of experienced professionals who sometimes provide in-depth analysis and suggestions.

Benefits of trading in commodities

Here are some benefits which investors can get if they trade in commodities:

Facilitates diversification: Commodity trading allows you to lower the risk of capital loss and effectively diversify your assets. Commodities typically move in the opposite direction of equities or bonds. For instance, investors could get fearful and move their money out of equities and bonds and into secure commodities like gold or silver if two countries unexpectedly start a war.

On the other hand, investors may sell gold and silver and switch to stocks if the economy expands and businesses show a notable increase in earnings. Therefore, using commodities in your portfolio can help you minimise risk and maximise return.

Inflation: The word inflation is shunned by consumers of tangible goods. But inflation may be your best friend if you trade in commodities. All inflation indicates is a rise in the cost of goods. Thus, your portfolio value will rise if you own a commodity whose price is rising. This guarantees that even in the event of an all-time high inflation rate, your buying power will not change.

When inflation increases, stocks and bonds often experience a decline because rising prices frequently dry up liquidity and lower purchasing power.

Liquidity: Commodity investments are more advantageous than real estate or fixed deposits since they are 100 percent liquid and may be sold at any moment. Commodities are simple to purchase and sell, just like stocks. Therefore, if you are looking for greater control over your money, commodities derivatives can be a good investment.

Read more: What is an ETF? Explaining exchange traded funds

What moves commodities?

Returns on investments in commodities are depending on a variety of factors, each of which has a unique function. Let’s take a look at some:

Cost variations: Variations in carry costs, storage, insurance and financing cause basic gains or losses to change.

Currency fluctuations: Since the majority of commodities are valued in US dollars, shifts in the value of the dollar can have a significant impact on commodity prices. While a higher dollar has the opposite impact, a weaker dollar makes goods cheaper in foreign currencies, thereby increasing demand.

Economic and geopolitical stability: Commodity prices are very susceptible to fluctuations in significant places, political events and economic policies. Supply chains can be disrupted and prices impacted by wars, political upheaval, or economic sanctions in the region where a product is produced.

Global economic trends: The demand for certain commodities is significantly impacted by the state of the world economy as a whole. Demand usually rises during economic expansions, whereas it falls during recessions.

Government rule and policies: Commodity prices are affected by trade agreements, tariffs, subsidies and environmental laws. Subsidies and incentives to certain industries can boost supply and potentially cut prices, whereas trade and production restrictions might raise prices.

Rates of inflation and interest: Commodity investments typically act as a hedge against inflation. Commodities usually increase in value in tandem with inflation, offering some protection to investors who include them in their portfolio. Changes in interest rates can impact the cost of financing or holding commodities, which in turn can have an impact on commodity prices.

Market speculation: Changes in the present pricing of commodities can be caused by traders making predictions about future prices.

Costs associated with storage and transportation: The costs associated with storing and moving commodities, particularly perishable items, can fluctuate greatly and have a substantial impact on their pricing.

Demand and supply: This is maybe the most important element. Prices of a commodity increase when supply is less than demand. On the other hand, when supply exceeds demand, prices decrease.

Other ways to trade in commodities

There are many other ways to trade in commodities. Let’s take a look at some:

Direct investment: It is the widely used method to invest in commodities. For instance, you may buy gold and silver immediately in the form of coins and jewellery. Direct investing in these things, however, comes with a hefty transaction fee. There are also problems with purity and storage.

Purchase stocks: This is another method of trading in commodities. For example, you can purchase stocks of an energy firm if you want to trade in energy. The price of energy will have a direct impact on stock prices. Even in the event that the commodity is underperforming, direct stock investments in commodities might provide gains. For example, if you have invested in shares of a well-established energy firm, you can still earn profit from declining energy costs because of the company’s strong fundamentals.

Conclusion

Commodities provide investors and traders protection against events such as inflation and can aid with portfolio diversification. Although commodity trading carries a significant risk, it also has the potential to yield large gains. Gaining an in-depth knowledge of the dynamics of supply and demand in the commodities market, together with inflation, is crucial. As always, thoughtful contemplation and patience are essential, as well as thorough research.

Frequently Asked Questions (FAQs)

What are commodities in trade?

A commodity is a basic good traded in large volumes and interchangeable with other goods of the same type. Commodities are either for immediate delivery in spot trading or for conveyance later when traded as futures. Commodity markets deal in metals (aluminum, copper, gold, lead, nickel, silver, zinc, etc.)

What are the risk involved in commodties trading?

Price volatility: The prices of commodities can be highly volatile, which means that Indian investors can potentially make or lose a lot of money in a short period of time. This volatility can be attributed to various factors, such as weather conditions, political events, and global demand.
Leverage: Commodity trading often involves the use of leverage, allowing traders to use more money than is present in their account. While this can magnify potential profits, it also increases the risk of significant losses if the trade goes against the investor.
Limited liquidity: Unlike stocks, which are traded on a continuous basis, many commodities are traded in limited quantities. They can be difficult to sell at a desired price. This can make it challenging for Indian investors to exit a position quickly if they need to.

How does supply and demand impact commodity prices?

A rise in demand against a limited supply will typically lead to higher prices. However, an increase in supply, if not matched by demand, can cause prices to fall. These shifts can be influenced by a multitude of factors, including geopolitical events, environmental conditions, and technological advancements. The strategic nature of certain commodities, such as oil and rare-earth metals, further underscores their importance. It is because their pricing can have significant geopolitical consequences.
What is the difference between physical and futures commodity trading?
Futures are kind of of financial derivative in which you agree to buy or sell a particular asset at a specific price at a particular time in the future. Whereas commodities are kind of asset that represents fungible goods, such as oil, iron ore, or wheat. Generally, commodities are traded using futures.
What tools are essential for commodity traders?
Technical analysis is widely used by traders as it is useful for making short-term decisions in markets. It creates charts by analyzing historical price patterns, trends, and volume to predict future movement.
What is the role of futures contracts in commodity trading?
An agreement to purchase or sell a predefined quantity of a good at a given price on a given future date is known as a commodities futures contract. Commodity futures can be used to speculate on the direction of the underlying asset’s movement or to hedge or protect an investment position.

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