For investors looking for newer avenues to trade, commodity trade provides the right kind of portfolio diversification and offers gains across different areas of the economy.

India’s economy is growing rapidly, which offers investment avenues for those with disposable income to invest in the country’s future and earn returns.

However, capital markets are considered to be the most lucrative of all. In capital markets, one can invest in equity or debt through stocks, bonds and mutual funds. But this is not all. Those looking for further diversification and investment avenues can look towards commodity trade as a viable investment avenue.

As of now, commodities trading is not quite as popular as other instruments but that’s changing fast with the rise in awareness about the commodities trade as well as the hunger of investors to chase better returns.

Requirements to start trading

To start trading in commodities, one requires a Demat account just as they would require one to trade in shares or mutual funds on the stock market. A Demat account functions like a bank account except for your holdings in the stock market or the commodities market. It stores the information of your trades as well as the actual holdings of the instruments that you have invested in.

A Demat account can be opened with the National Securities Depository Limited to start trading in the commodities market.

Now, the commodities market allows one to trade in many kinds of commodities. They are split into agriculture, precious metals, energy,  services and metals and minerals. The trading options range from base metals such as aluminium and zinc to grains, pulses, gold and coal.

These commodities are listed for trade on the exchanges just the way shares of various companies are listed on various indices for people to trade in them. There are 22 exchanges currently operational in India. The Forward Markets Commission is the entity which regulates these exchanges and all commodity trade activity in India. The major exchanges include Multi Commodity Exchange of India (MCX),  Universal Commodity Exchange, National Multi Commodity Exchange of India and the National Commodity and Derivative Exchange (NCDEX).

Instruments of trade

Commodity trade can be done through a special form of an instrument called a commodity future. A commodity future is a contract through which a buyer and seller of a certain commodity agrees to buy the commodity at a pre-agreed date in the future at a pre-agreed price. This kind of contract allows traders to make gains when they buy the right kind of future contract whose pricing reflects the general movement of the commodity’s spot price.

For instance, silver could be trading at Rs 50,000 per kilogram in the commodities market. Now, an investor can buy a future for silver priced at Rs 51,000 for a date after 30 days from the date of the contract. This means that after 30 days, the investor will be paying Rs 51,000 to buy a kilo of silver from the seller.

However, if the market moves up i.e. the price of silver rises during this period and the commodity becomes expensive, say, Rs 53,000 per kilo. Then, the buyer of silver can technically buy the silver at Rs 51,000 from the seller and sell it in the open market at Rs 53,000. This is how calculations are done for gains and losses and the settlement amount is credited/debited after taking into account the spot price, target price and the current price.

Types of contracts

However, this kind of settlement is possible only in cash-settled futures contracts. There are delivery based contracts available in the market too where one has to show warehouse receipts to be able to make the trade. On the expiry of those contracts, the actual delivery of the item is made as agreed upon in the contract.

While placing an order for a futures contract, investors can choose whether they want a cash-settled contract or a delivery based contract. It is important to remember that the type of settlement can’t be changed on the day of the contract expiry.

Conclusion

Commodities trading is a good move for most investors if they understand the market and know how to trade effectively. An underlying knowledge of the commodities is necessary to be able to make intelligent trades and it is always helpful to consult a broker who can guide you in this journey.