What is Commodity Trading? How does it work?

Commodity Trading – You must be aware of making money via stock trading do you know that you can also make money via commodity trading? Well, commodity trading is done in the commodity market. A commodity market is one of the oldest markets. In good old days, commodities were exchanged with other commodities using the barter system and it was location-specific. Now, we have electronic exchanges for doing commodity trading. In this post, we will deep dive and take a bigger look at commodity trading and How it works?

What is Commodity?

A commodity is defined as basic raw material, goods, agriculture, mining items that can be bought and sold in the market. Commodities are extracted from natural state and brought up to minimum grade for the sale in the market. There is no extra value added to them by the producer. 

In general commodities are things or items which are used in daily lives. Examples of a commodity are tea, coffee, gold, silver, wheat, chana, soya oil, copper, zinc, lead, crude oil, natural gas etc. All these items are traded in the commodity market.

What is Commodity Trading?

Commodity Trading means buying and selling of commodities in a short period of time for making money. Trading of the commodity is done in the same manner as that of equity/shares. The trading in commodities take place either in the spot market or future markets. 

There are four major commodity trading exchanges in India. Details are given below.

1. Multi Commodity Exchange – MCXNational Commodity and Derivatives Exchange – NCDEX
2. National Multi Commodity Exchange – NMCE
3. Indian Commodity Exchange – ICEX

There are four different types of Commodity category where trading takes place. 

1. Metals – Silver, Gold, Platinum, and Copper
2. Energy – Crude oil, Natural gas, Gasoline, and Heating oil
3. Agriculture – Corn, Beans, Rice, Wheat, etc.
4. Livestock and Meat – Eggs, Pork, Cattle etc.

Also Read – 10 Best Small Trading Business Ideas

How Commodity Trading Works?

Commodity trading is the trading of a commodity where buy and sell activity of various commodities described above takes place. The trading takes place based on current and future date. 

Commodity trading works based on supply and demand. If demand is high and supply is less price will increase. On the other hand, if supply is high and demand is less price will fall. For example, a price of gold future is affected by the wedding season or situation of gold mining companies. The price of oil futures is affected by the political situation in the oil-producing countries. Let’s try to understand this by one example.

Example –

A trader purchases a gold future contract with a minimum contract size of 100 gm at Rs.75000 on MCX. He pays margin money 4% which is equal to Rs.3000.

If on next day gold price trade at Rs.72000, the difference of Rs.3000 will be debited from the trader account. Suppose gold trade at Rs.76000, the difference of Rs.1000 will be credited to the trader’s account. 

If you want to become a commodity trader you need to follow the step given below.

1. Open commodity trading account with a broker. This account is required for doing online trading of commodities. You need to submit an application form along with all necessary documents to open trading account.
2. Once your account is open, you need to deposit margin money. The margin amount is 5-10% of the contract value. In addition to margin money, additional money is also required this is to recover money in case you face losses. 
3. Once this formality is over, you can place an order. You need to understand market dynamics and supply-demand of a commodity before placing an order. Once you finalize on commodity, lot and contract value you can inform broker for the placement of order. Alternatively, you can also place an order at an online platform. The contract will be owned by the trader and it will be marked to market at the end of each trading day.
4. At the end of each day, settlement take place where commodity price is decided. The price of settlement is compared with order price and the difference is either credited or debited based on which the order was placed. 
5. The contract can be terminated by taking physical delivery of goods. The trading can also be closed by taking a reverse trade position. 

Benefits of Commodities Trading 

There are multiple benefits of commodity trading. A few of them are given below. 

Over to you –

Please note that commodity trading is a very good profession. However, it is risky. You need to understand the concept of supply, demand, and inflation before starting trading. Initially track and follow a single commodity once you get the confidence you can start trading.