Basics of Commodity Trading

This article is all about the basics of commodity trading. If you are trading in the stock market and if you want to trade in the commodity market too, then this article is for you. A commodity market is a derivative market. You might have heard about the equity market which trades using future and options. Similarly, the derivative market also uses futures and options for trading based on the underlying asset. For example, if cardamom has a spot price of Rs.1000. When the spot price fluctuates, the future and options fluctuate. 

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Participants of Commodity Trading
The participants of this market are speculators and hedgers. Speculators are the traders who buy and sell the commodity. Hedging is a process of minimizing loss. For example, if I cultivate cardamom and I have invested over Rs.10,00,000 with a selling price of one kg of cardamom as Rs.1000. I expect an increase in the selling price of cardamom to Rs.1200 with an intention as it would increase in price over certain factors for 4 months. Unfortunately, a huge supply but less demand is leading to the fall of the market. This causes a reduction in the price of Rs. 800 per kg leading to a loss of 20% i.e, around Rs.2,00,000. The online trading platform that is used to minimize the loss is MCX exchange. By selling the cardamom at Rs.1000 and buying it again for Rs.800 when the market falls you can recover from the loss in the online market. A minimum margin amount of 10% has to be paid to hold the position over some time and to minimize the loss. Thus the commodity market is used for hedging. Apart from this, retailers also buy and sell commodities.

Multi Commodity Exchange (MCX)
The exchange used here is Multi Commodity Exchange (MCX) which is similar to NSE and BSE in the equity market. When the price of any product such as crude oil, cardamom, etc increases, you cannot buy them directly from an exchange. You need an intermediate or a commodity broker. The exchange provides a membership. There are many commodity brokers. You can choose a reliable one and open a trading account with the help of a broker. Now you can buy an underlying product, hold them for a while, and sell them at a reasonable rate. The responsibility of a broker is to help you to buy or sell the underlying product you wish and provide an online platform for trading. The online platform can be accessed through mobile, laptop, or any media.

Segments of Commodity Products
The commodity products are classified into several segments. Gold and silver come under the billions sector, crude oil and natural gas fall under the energy sector, metals include copper, zinc, aluminum, lead, etc. and the agricultural sector includes national products such as cardamom, rubber, mentha oil, and cotton, etc. mostly people who wish to trade commodities use MCX exchange to trade national products because these are global products which have more liquidity and references. For example, if you want to trade cardamom you must need some references to predict its value either it would increase or decrease. Hence if you want to trade you can focus on international products.

Why Do We Need Commodity Trading?
The general thought that arises in our mind is why do we need commodity trading? It is because of its volatility. For example, in the stock market, in bajaj finance, the price has fluctuated about Rs.5000 to Rs.3000 i.e, around 40% down. In these 52 weeks, the price rose to about Rs.8000 i.e, around 60% up. Hence there is a fluctuation of  Rs.3000 to Rs.8000. When you consider Gold, the price per gram is Rs. 4500, the price drops to about 10% or raises to about 10%. So, the maximum volatility of the commodity is 20%. This is the best platform for people who have experienced many price fluctuations and losses in the stock market. 

The span margin for Tata motors in the future trading is around 20% to 25% that is around Rs.2,50,000. The span margin in the commodity market is about 5% to 10%. For a product worth 5,00,000, you can hold the position by paying about 50,000 as a margin amount. Hence the volatility and span margin are the advantages in commodity trading.

Online Trading features
The online trading features include Less margin, Fewer charges, Easy break-even, Time savings, Transparency. When you have an intention as there would be a price rise of gold in a short term from 4500 to 5000 and so you plan to buy them and hold for 6 to 9 months. When you buy that from a shop for about 1,00,000 along with additional charges as GST of about 3% i.e, Rs.3000 and wastage of about Rs.1000. As you have to pay an additional amount of about Rs.4000. But if you purchase the same gold online you have to pay only Rs.1,00,000 with an additional charge of about Rs.50. Since the charge is less there would be break-even. When the price of gold rises even about Rs.20 per gram you would get a profit on buying online. Hence on buying physically, you would acquire the actual profit only when it is above Rs.4000 which may take one or two months. There would be a price variation on going to shops but in the case of online the price is accurate and you can buy at that price. There would be much more time saved on buying online through mobile than visiting the shops.

Comparison between the stock market and commodity market
Here are some comparisons between the stock market and the commodity market. In the stock market, the stocks are listed and traded. Similarly, in commodity trading, the products are listed and traded. The products include gold, silver, copper, aluminum, nickel, led, crude oil, natural gas, etc. are traded along with agricultural products. The timing in the stock market is about 9.15 to 3.30 whereas, in a commodity market, the timing is about 9 to 11.30 or sometimes at seasons about 11.55. This is the running time of the Indian market. Since it is a global trade, the price fluctuates for 24 hours but we are authorized to trade only in the above said time limit. Thus the price of crude oil, gold, or silver fluctuates even at midnight. For example, the [price of crude oil has risen about one dollar, i.e, in Indian money, it would be about Rs.76 but you cannot book the trade. You can close the trade only when the market is open. The regulator for both the commodity and equity markets is SEBI. The regulator used before is Forward Market Commission (FMC). Later it was taken over by SEBI and the regulations are very strict. 

Things to be Considered in Derivative Market
The three important things to be noted in the derivative market is that you cannot take any delivery for storage. You do not have Demat delivery but you have physical delivery for Gold, silver, copper, etc. if you are an industrialist who requires material, you can purchase gold online and get delivered through an instruction slip. Retail participants do not trade till delivery but industrialists do. You do not need to have a Demat account but you can take physical delivery or sell the product. You do not need to pay a 100% margin. You can pay only about 10% to buy, hold, or sell the product.  There would be a predefined lot size for each product like 100, 1000, etc. you cannot buy it in kgs but only with the lot size. For example, a barrel of crude oil trades for about Rs.5250. It is necessary to know about the price. For instance, if the crude oil trades for about 70 dollars in Indian money it is about 70×75 is the 5250. The base currency is the dollar. Every country converts it to their own money. It is like a mirror, when there is a fluctuation in the dollar, then there would be a fluctuation in the Rupees. So, 5250 x100 (which is the minimum lot size) = 525000 is the total value. At present, the span margin is fixed about 13% so you have to pay around 68500  to initiate the trade.

Mark to Market (MTM)
There is a mark to market (MTM). you have bought a position by paying 68500 with the price 5250. In case, there is a price drop from 5250 to 5200. Hence 5200 x100= 520000 i.e, Rs. 5000 would be reduced but you have to maintain the 68500 or else, the broker asks for the additional funds to hold the position. If you transfer the fund your position will be held or else the Risk Management System (RMS)would cut your position. Hence it is the best choice to have some extra amount while trading.

Types of Trading
There are two types of trading as Intraday trading or Carry Forward or Positional Trading. Intraday trading is the trading carried out on that particular day. If you are at a loss or profit and you want to carry that position to the next day. Then it is said to be carry forward trading. The charges are the same. When you initiate a transaction you have to pay Rs.20, there won’t be any additional charges for carrying forward and on selling the product the same Rs. 20 is charged. Hence it is necessary to know the types of trading. In those days, intraday trading was done by the brokers who provided trading exposure which was completely banned by SEBI in recent times. There are step by step processes as 20 times, 4 times, 1.3, and finally, a one-time exposure is available. Intraday was very beneficial in those days as you have an amount of 1,00,000 you would obtain a trading exposure of about 20,00,000. You must complete the transaction within the day. In one-time exposure, both intraday and carry forward are the same. You must have a look at the MTM adjustments. Don’t trade with the exact amount of 68500. This is because there would be price fluctuation and volatility due to which the span margin is fixed both in the morning and in the evening. In the evening when the span margin is fixed as 70,000 then there would be an increase of about 2000. Then you have to support the broker with another 2500. Thus it is necessary to hold some extra amount while trading.

Price Moving Factors
Certain factors cause price fluctuations. For example, when the price of crude oil increases, the reasons would be demand and supply. In particular, on Wednesdays, they would provide inventory data about the availability of stocks and expectations and actual stocks. When there is a demand in stocks the price of crude oil increases and there is no demand the price decreases. The United States would provide economic news on Thursdays about unemployment and applicants. When there is an increase in unemployment then there would be a fluctuation in the price of gold, silver, etc. another important reason for fluctuation is currency fluctuation. When the price of crude oil per barrel is 70 dollars and in Indian money, it is 70 x 75 =5250. When the value of base currency i.e, the dollar increases then there would be a price fluctuation of 71 x 75. Sometimes the price fluctuates even when the dollar does not change its value. This is because of the strength and weakness of the Rupees.  When the rupee changes from 75 to 76 then there would be a fluctuation in price. Sometimes customers could not understand the reason why there is fluctuation in price even though the dollar does not change.

Finally, technical analysis is also a reason for price fluctuation. For example, natural gas is about Rs.280 in recent times. When this 280 broke out, it reached 480.  Support and resistance and the trend analysis come under the technical analysis. There are price fluctuations due to technical analysis when the participants increase in the transaction between buyer and seller these are taken into consideration. Every trading has a few charges such as MCX turnover charges, CTT (Commodity Transaction Charges) SEBI charges, CM (Clearing Member) charges, GST, Brokerage charges. When you trade around 1,00,000 you would get a charge of RS. 10 and brokerage of Rs.10. For example, when you buy crude oil with a value of 5,00,000 and sell it at the same value. Then for a transaction of about 10,00,000, there would be a charge of about 200. The brokerage varies among the brokers while the other charges are common. The charges vary due to the variation in the brokerage. It is better to discuss with the broker before opening a trading account.