What is Commodity market & Commodity Trading?

Oct 14, 2019 | 1 month ago | Read Time: 3 minutes | By iKnowledge Team
What is Commodity market & Commodity Trading?

A commodity market is a virtual marketplace for trading raw products like gold, silver, oil, etc.

People may not understand much about stocks, but they would certainly understand a lot about the food they consume such as wheat, sugar, jaggery, pulses, grains, etc. These are commodities which people buy on a daily basis and they are updated about them with regard to their prices and how certain items of consumption fluctuate seasonally when there is a fall or spike in demand.

Investing in commodities is a good way to diversify the investment portfolio. One of the basic trends is that commodities usually move in the opposite direction to stocks. If stocks are not your thing, or if you feel that the stocks are in a bear phase then you can use commodities to boost your portfolio.

Compared to shares and bonds, commodities are actually less volatile, because commodity cycles last longer and trends persist.

Can you invest in commodities?

Well, being ordinary people we would not naturally be in a position to buy and sell wheat, or buy 100 numbers of cattle and sell them later at profit. So the next best thing and the best plan for investments in commodities is to invest in commodity futures, which are bundled contracts on exchanges, with the underlying being the actual physical assets. So if you are buying mustard oil futures, the underlying asset would be mustard oil and we know what the prices of mustard oil are. There’s no painstaking fundamental analysis to be done as it is all based on supply and demand of the commodities.

Commodities fall into five major segments: agriculture, metals & materials, precious metals, energy and services.

Under agri-commodities there are a whole host of items ranging from oil seeds, pulses, grains, spices and fibres. Metals and materials include steel, copper, nickel, tin etc. Precious metals are gold and silver (commonly called bullion). Energy includes crude oil, power, etc. and services include mining and oil services.

How to trade in commodities

In order to invest in commodity futures one needs to sign up with a broker who is a member of a commodity exchange. Most major institutional stockbrokers in the country also have membership of a commodity exchange.

One can start trading in a futures contract for as low as Rs 5,000 margin money, because the margin requirement in commodities is around 5 to 10 percent the contract size. Investors need to be aware of the risks here, as the lower commitment may induce them to take higher exposures.

Also in the case of commodities, the unit of measurement depends on the commodity. It can be kilograms to tons, pounds to bushels etc. For instance, oil futures are traded in barrels. Commodities markets are dominated by arbitrageurs who are responsible for most of the volumes in the market. They play on differing prices globally, either in the same commodity or across commodities, offsetting their position in one commodity with an opposing position in another.

While commodities are generally less volatile compared to stock markets, the major risk to this segment comes from changes in government policies. For instance, in India trading volumes in gold futures took a hit after demonetisation as people feared a lessening in gold sales. In fact gold futures has remained depressed since. Any policy changes on Agri-products will have a direct impact on the futures. It is important for investors to be aware of policies for this reason. In 2007,the government had suddenly banned trading in food grains and pulses sending the prices down.  Therefore, as a retail investor, it would be best if you stick to the commodities you know and are familiar with. Since the margin amounts are low, it is best to start out with small amounts. That way if the call goes wrong, the losses will be limited.

Instead of taking the trouble to keep track of commodity prices, it is far easier to invest in a ready-made product. To know about Aegon Life’s life insurance products like term insurance and other products, visit our home page.


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