Commodity Trading and Exchanges in India
A Commodity refers to a good or resource that is a part of our everyday life and sometimes used as a raw material in production by companies. Some general examples of commodities are Gold, Silver, Sugar, Coffee, Steel, etc. You can start trading in these commodities through the Future and Options (F&O) Segment of the Stock Market.
History of Commodity Trading in India
In India, Commodity Trading began even before the trading of Stocks. It started as early as 1875 with the establishment of the Bombay Cotton Trade Association. As the market developed, other commodities such as edible oilseeds complex, raw jute and jute products, and bullion entered the Futures Segment.
However, the commodities segment was stopped in 1960 due to various unstable economic parameters such as war, natural disasters, and other economic issues. Commodity trading was given a fresh start after economic stability was restored in the country through the policy of Liberalisation, Privatisation, and Globalisation (LPG) in 1991. At the start of 2002, there were around 20 commodity exchanges in India dealing in 42 commodities. The Government of India allowed trading for all commodities from April 2003.
What is Commodity Trading?
Commodity Trading refers to buying and selling of commodities by investors through the medium of stock exchanges and brokers. The various types of commodities are as follows:
- Agriculture: Rice, jeera, turmeric, red chili, chana, urad, castor oil, coffee, etc.
- Metals and Minerals: Aluminium, steel, bauxite, chemicals. Copper, etc.
- Precious metals and materials: Gold, silver, platinum, and palladium.
- Energy: Crude oil, natural gas, Brent crude, thermal coal, etc.
Also Read: Stock Market Indices in India
How does Commodity Trading Work?
You can trade commodities through derivatives contracts such as futures and options. A Futures Commodity Contract is a standardized agreement to buy or sell a specific quantity of a commodity at a pre-decided price in the future. The contract specifies the lot size (order quantity), the location of delivery, the type, and quality of commodity along with the pre-decided price and date on which the transaction has to be completed.
When you purchase a commodity through an exchange, you only have to pay a fraction of the cost, known as Margin. This is because commodities are high leverage instruments. For example, the current price of Gold is Rs. 50,000 and the margin for gold decided by NCDEX is 5%. This means that you only have to pay Rs. 2,500 for the Gold Futures. The subsequent profit or loss will be debited or credited from your account as per the market price movements.
- High Leverage Instruments: You can start trading with a lower amount of money and make a bigger bet. This allows you to purchase higher quantities with the same amount of money.
- Highly Liquid: You can enter and exit a position very easily due to high volumes and good participation by institutional investors.
- Potential for Huge Profits: As commodities are highly leveraged instruments, you can purchase a large quantity with a small amount of money. This allows you to make more profits if the price moves according to your prediction.
- Hedging: Commodity trading allows you to hedge against extreme events, also known as Black Swan events, which may result in huge losses for your portfolio.
- Inflation: Trading in various commodity futures allows you to protect yourself against any price rise.
- Marked to Market Settlement: Futures contracts are settled daily by the exchanges and you can exit your position any time before the expiry of the contract.
- Portfolio Diversification: Investing in commodities will help you to diversify your portfolio and reduce your exposure to a single asset class.
- Huge Losses: The high leverage in a futures contract is like a double-edged sword. New traders can face huge losses if they do not trade carefully. Purchasing in higher quantities due to high leverage increases the magnitude of risk if the trade does not go in your favor.
- Volatile Markets: Futures markets are highly volatile and may even wipe out your entire wealth. You need to be aware of the risks before investing in this market.
- Concentration in specific commodities: Commodity ETFs are generally concentrated in 2 or 3 commodities, thereby increasing your exposure and defeating the purpose of diversification.
Commodity Exchanges in India
You can invest in commodities through various commodity exchanges in India such as:
- Multi Commodity Exchange – MCX
- National Commodity and Derivatives Exchange – NCDEX
- National Multi Commodity Exchange – NMCE
- Indian Commodity Exchange – ICEX
- Ace Derivatives Exchange – ACE
- The Universal Commodity Exchange – UCX
How to invest in commodities?
Once you have selected your broker, you can start your investment journey in commodity futures through your Demat Account. Many brokers have partnered with commodity exchanges such as MCX, NCDEX, and others, which enables them to offer commodity trading services. Some brokers offering commodity trading services in India are Motilal Oswal, Zerodha, Upstox, Angel Broking, Kotak Securities, Sharekhan, and many more.
You can buy commodity futures when you expect the price of a commodity to rise. On the other hand, you can sell commodity futures when you expect the price of a commodity to fall. All of these transactions can be carried out through your broker. The settlement of the contract happens on a cash or delivery basis, depending on the option selected by you.
Also Read: Primary Markets in India
Why do people trade in Commodities?
Some market participants trading in commodity markets are:
1. Hedgers: Buy or Sell to reduce the risk of already existing (or upcoming) financial exposure. Their primary objective is to hedge against any rise or fall in commodity prices. For example, a firm selling Brent crude oil can purchase a futures contract for Brent crude oil to protect itself from any price decline in the future.
2. Speculators: They enter into the market to earn profit by buying or selling the commodities. They have a good amount of knowledge and experience of the market. For example, Trading firms, Investors, companies, etc.
Commodity trading is very risky and requires a lot of capital. You should have a good amount of experience in trading and financial knowledge before entering the F&O Segment, as this will help you to make informed decisions.