Basics of Commodity Trading in India

Commodity Trading in India: Basics and FAQ - Angel Broking

What is a commodity?

A commodity is a group of assets/goods that are important in everyday life, such as food, energy or metals. A commodity is alternate and exchangeable in nature. It can be categorized as every kind of movable good that can be bought and sold, except for actionable claims and money.

Commodity trading in India started way back in time, even before it did in many other countries. But, foreign invasions and ruling, natural calamities, and countless government policies and their amendments were major reasons for the diminishing of commodity trading. Today, even though there are various other forms of stock market/share market trades, commodity trading has regained its importance.

Where to invest in commodities?

There are six major commodity trading exchanges in India as listed below:

  • 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

In 2015, the regulatory body of the commodities trading - Forward Market Commission (FMC) merged with Securities and Exchange Board of India (SEBI). Commodity trading in these exchanges requires standard agreements as per the instructions so that trades can be executed without visual inspection. In general, commodities are classified into four types:

  • Metals - Silver, Gold, Platinum, and Copper
  • Energy - Crude Oil, Natural Gas, Gasoline, and Heating Oil
  • Agriculture - Corn, Beans, Rice, Wheat, etc.
  • Livestock and Meat - Eggs, Pork, Cattle, etc.

How to invest in commodities?

The best way to invest in commodities is through a futures contract, which is an agreement to buy or sell a specific quantity of a commodity at a set price at a future time. Futures are available on every category of commodity. Traders use these contracts as prevention towards the risks associated with the price swing of a futures' implicit trade good or raw material. Trading in commodities involves high risk for the amateur investors.

What are the advantages and disadvantages of futures?

Advantages of futures:

  • Futures are highly leveraged investments
  • Future markets are very liquid
  • If traded carefully, futures give huge profits
  • Affordable minimum-deposit accounts and controlled full-size contracts
  • Long or short futures can be set as target easily

Disadvantages of futures:

  • Futures markets are volatile
  • Direct investment in the markets is of high-risk, especially for novice investors
  • Gains and losses are magnified by leverage
  • Unpredictable movement of trade even before you close your position

More than 100 commodities are traded in the commodity futures market. Out of these, 50+ commodities are actively traded. These include bullion, metals, agricultural commodities, energy products, etc.

What is Exchange Traded Funds and Exchange Traded Notes?

Investors can participate in commodity price fluctuations. Trading in commodities without directly investing in Futures is possible with Exchange Traded Funds (ETF) and Exchange Traded Notes (ETN).

Using futures contracts, a particular commodity or group of commodities comprises an index. The price of these indexes is usually tracked by commodity ETFs. However, to simulate the fluctuations in price or commodity index supported by the issuer, ETNs are dedicated. ETNs are unsecured debts and both ETFs and ETNs do not require any special brokerage account to invest.

What are mutual funds and index funds in commodity trading?

It is quite impossible for direct investment of mutual funds in the commodity trading. Rather, there is an investment in stocks of the companies involved in commodity-related industries such as energy, food processing, or metals and mining.

Investing in stocks of such companies involve high risk, specifically company-related risks. The investment in a small number of commodity index mutual funds in futures contracts provides direct exposure to the commodity prices. Even though the management fee is slightly high and there is no fair play in the stocks, there are certain advantages of investing in mutual funds in commodity trading, including diversification of the investments, liquidity, and proper money management.

What is MCX trading?

The trade of commodities in the commodity market facilitated by the MCX (Multi Commodity Exchange) is often referred to as MCX trading. MCX provides a platform for trading in commodities, just like BSE and NSE provide platforms for trading in stocks. An MCX broker (working at investment banks or broking companies registered with MCX) is the one who acts as an intermediary between the commodity trader and commodity exchange (MCX in this case). MCX trading allows trade in metals, energy, and agricultural commodities. The MCX conforms with the regulatory framework of Forward Market Commission (FMC) that was merged with Securities and Exchange Board of India (SEBI) in 2015.

How to choose a commodity broker?

Choosing the right commodity broker is a crucial part of the investment experience. The vast scope in the market has brought employment to many brokers.

But, credibility and experience mark the impression of a good broker. Every investor should do thorough filtration while selecting a broker. The charges that a broker quotes to a client may vary from place to place. Choose a broker wisely depending on the offers and fee waivers. Comparison of brokers on the basis of their charges might sometimes go futile.

Before signing up with the broker, the investor should check the platforms or media through which the investments are going live. A demonstration of the application or media is advised for novice investors. In India, the investments could be going live on the Multi Commodity Exchange when the trader is using an MCX broker service; or on other commodity exchanges such as NCDEX, NMCE, etc. depending on the commodity broker.

A broker with a strong and proactive customer support team is highly appreciated in the market. Relying completely on a broker without any proper market research may put the investor into losses. Select a right certified commodities broker, and understand the process of depositing with a margin to complete the transactions.