Commodity trading is a common term in investment parlance. Apart from stocks, various commodities are traded in markets, investing in which can help you diversify your portfolio and augment gains. If invested with prudence, commodities can provide good returns in the long run thanks to their changing prices over time.
What are Commodities?
Commodities are basic raw materials used to produce goods for everyday use. The building block of a global economy, commodities include items such as oil, sugar, metals, and so on. The types of commodities traded in India can be categorized into four broad categories (see table below).
Gold, corn, crude oil, coffee, wheat, etc., are some of the most widely-traded commodities across the globe. The price movement of one commodity has an effect around the world. For instance, whenever there is a jump in crude oil prices, the impact is across the globe.
Commodity Exchanges of India
Like stock exchanges, there are commodity exchanges in India. Some prominent commodity exchanges of India are:
How To Start Trading in Commodities?
To begin with commodity trading, the first step is to know about the types of commodities that exist (mentioned above). Then you need to:
Open a Demat Account with a Reputed Stockbroker
Just like you need a demat account to trade in stocks, you need a demat account to trade in commodities. While there are multiple brokerage houses where you can open an account, it’s essential to opt for a reputed firm that provides you key recommendations regarding trade. You need proper input and guidance to navigate the commodity market maze.
Equally crucial is to opt for a brokerage that offers competitive rates. Choosing a broker with a high brokerage fee can eat into your gains. Check out the services offered by the broker on its platform. In your interest, go for a full-service broker as they have a team of experts who provide in-depth research and recommendations from time to time.
Deposit an Initial Amount
After you have opened an account, you need to make an initial deposit. The deposit amount is generally 5% to 10% of the contract value and depends on the commodity you are trading.
You will find this information on the official website of the brokerage house. You need to maintain an adequate margin to cover up for losses if any. Equally essential is to devise a commodity trading plan that helps you better understand markets and your risk appetite. Every trader is different in terms of risk preferences and cash flow. You make a choice depending on your financial positioning.
Different Ways to Trade in Commodities
There are several ways to trade in commodities. These include:
It is the most common way to invest in commodities. For example, you can directly purchase items like gold and silver in the form of coins and jewellery. However, direct investment in these items entails a high transaction cost. Also, there are issues related to storage and purity.
This is another way to trade in commodities. For instance, if you wish to trade in energy, you can buy stocks of an energy company. The stock price will closely follow the price of energy. If you invest in commodities through direct stocks, there are chances of making profits even if the commodity is not doing well.
For instance, if you have purchased shares of an established energy company, even if energy prices are going down, you can still make profits given the company’s sound fundamentals.
Commodity ETFs and Mutual Funds
There are many ETFs and mutual funds based on commodities. For example, if you want exposure in gold or silver, you can invest in gold or silver ETFs. There are no purity or storage-related issues with ETFs as the units are held electronically in your demat account.
Commodity trading can be beneficial if you get the basics right and accurately estimate your risk appetite. Have a proper plan and execute it to derive maximum value from commodity trading.
Commodity trading has two key benefits: diversification and hedge against inflation and geopolitical risks.
Diversification: Commodities expose your portfolio to a different asset class and provide it the balance it warrants. Diversification is a fundamental principle of investing and helps mitigate risks. A well-diversified portfolio is crucial to ride market volatility.
Hedge Against Inflation and Geopolitical Risks: High inflation, more often than not, pushes up commodity prices. Investing in commodities helps you maintain your power parity with rising prices. Hence, they act as a good hedge against inflation. They also act as a hedge against geopolitical events that can disrupt the supply chain leading to their scarcity.