How To Trade On Commodities – Commodities are products or goods that we use in our daily life like metal, food, energy, etc. Commodities are a collection of products that help you work effectively in your daily life. They are things that are marketable in nature or can be easily bought and sold. Commodity investing or commodity trading is very different from trading other types of instruments.
In commodity trading, price freezes are commonly used to avoid losses associated with large price increases in essential products. Commodity trading is considered risky so only experienced traders and investors try their hand at commodity trading.
How To Trade On Commodities
Let’s take a look at how a typical risk-averse investor can benefit from changes in commodity prices, without owning the commodity itself, and investing through ETFs, which require little research and expertise.
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A commodity ETF or exchange traded fund is a fund that focuses on the futures contracts of a specific physical commodity or product. These funds (ETFs) are in turn traded on a stock exchange. ETFs provide indirect exposure to commodity prices and avoid the risks associated with holding futures contracts.
Exchange-traded funds track the performance of multiple commodities or companies engaged in mining, extraction or development. Commodity ETFs allow investors to benefit from changes in commodity prices without investing directly in commodities through futures contracts.
Because gold has been considered a safe haven in difficult times since ages. Exchange-traded funds often hold gold because the underlying commodity is so popular in India.
These ETFs are considered less risky than traditional ETFs; Therefore, returns may be limited. Exchange-traded funds are often managed anonymously.
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Mutual funds, like ETFs, provide indirect exposure to the commodity market without trading in highly leveraged (risky financial instruments) such as commodity futures and options.
In the year According to the SEBI regulations issued in 2017, traders can trade in underlying commodities through options, which give traders the right but not the obligation to buy/sell the underlying commodity at a predetermined price on a future date. The fixed price at which the trader will buy or sell the commodity in the future is known as the strike price.
Unlike futures, where the trader is obligated to deliver a contract for the purchase and sale of an asset at a certain future date, an option contract gives the trader the right to withdraw from the contract. A business owner uses the right to buy or sell goods if he serves the interest of the entrepreneur or makes a profit from it. They earn this right by depositing a nominal amount known as the option premium.
Generally speaking, you buy a call option if you think the price of a commodity will rise and buy an option if you think the price of a commodity will fall.
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A call option buyer will make a profit if the strike or strike price at the time of purchase is 100 Birr and the current market price is 120 Birr and vice versa for options.
A commodity futures contract is an agreement to buy or sell at an internal price on or before a certain date in the future. In India, they provide futures for various commodities like wheat, cotton, petroleum, gold, silver, natural gas and other commodity futures.
Commodity futures are used by commodity producers to hedge against fluctuations in commodity prices during production, before the commodity is ready for delivery. For example, a farmer may buy wheat futures to lock in a price a month in advance, which is enough time depending on his guess and experience that it may take to produce wheat in its entirety. In the harvest season, not only at a reasonable price, but in the harvest season is guaranteed to the buyer.
Buyer confirmation for delivery of agricultural products such as wheat during the harvest is especially important in the absence of a future contract with agriculture, as it leads to loss of production due to the time lost in searching for a buyer. The items are highly perishable in nature.
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In addition, the futures contract ensures that there will be no change in the price of wheat during the harvest season, which can cause huge losses to the farmer and guarantees a reasonable rate of return.
A buyer of wheat may be a producer of wheat flour; The price of wheat is guaranteed. This allows him to plan the production program correctly, because he ensures the supply at the right time and does not have to look for wheat producers when it is most needed.
Also, he can determine the price of wheat flour because it has a certain price and can make management decisions to keep the price within a certain limit that ensures a reasonable margin.
Any interruption in wheat supply or price variation can disrupt the entire production schedule and even increase the price of wheat flour, making the product unaffordable for customers. Therefore, a futures contract is not a zero-sum game, but a win-win situation for both the buyer and the seller.
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Also, there is speculation in the futures market because of the high leverage that any small increase in price can generate huge profits. On the other hand, a small drop in price can lead to a large loss. However, speculations serve a purpose in the market as they increase market liquidity by ensuring that there are enough buyers and sellers.
You can invest directly in a physical commodity by buying a certain amount at a set price and then selling it at a higher price.
You need a large and spacious place to store many items, which is often difficult and impossible unless you are a farmer.
You also need specially designed storage areas to protect the items from adverse weather conditions, bad weather or weather shock.
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You need a comprehensive insurance plan to protect against unexpected events such as weather, natural disasters, man-made disasters that cause damage to goods, total or partial loss of goods during storage.
It is often impossible for a trader to find a buyer willing to pay the market price at the exact amount held by the trader, as opposed to an exchange that acts as a central location for buyers and sellers to facilitate constant, simultaneous and real-time matching. of buyers and sellers.
For example, imagine you bought 300 kg of silver and you live in a crowded city like Mumbai which does not have its own warehouse or warehouse. For a city dweller like you who only wants to profit from fluctuations in silver prices and has no desire to acquire physical goods, it is almost impossible for you to accumulate such a large amount.
Also, if you want to sell it, you have to find a buyer who wants the right amount of silver, 300 kg, and is willing to pay the market price, which is very difficult to find in this vastly entrenched area. The market. You should also be aware of the high costs incurred in maintaining and maintaining the quality of silver in storage.
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On the other hand, on MCX, you can buy 10 silver futures contracts for only 30 kg per contract. There are no physical commodities, no logistics, no warehouse requirements and you can buy or sell contracts at will. Moreover, you can take a position in the contract by depositing a small part of the money, as opposed to buying physical goods where you deposit the entire amount.
Therefore, considering the huge weaknesses and limitations, commodity markets like ETFs, futures and options as mentioned above are designed to gain price exposure without actually owning the price of commodities and to profit from changes in these commodity prices. .
Take the first step to start trading and investing in the commodity market and open a free commodity trading account today and get free brokerage for the first month with orders placed from the app.
By Deepika KhudeDeepika Khude, the author, is a Certified Financial Planner (CFP) with 5 years of experience in investment advisory and financial planning. His strength lies in simplifying complex financial concepts with real life stories and similar examples. Its aim is to make ordinary retail investors smart and financially savvy. , | Last updated: June 21, 2022
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The best way to invest in the commodity market is through futures contracts. Hey you
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