Commodity trading in India is growing at a fast pace with increasing retail investor participation. By participating in the commodity market, you get to capitalise on the short-term price movements of various commodities.
In this article, we are going to look at how to trade in the commodity market in India, the things you should keep in mind when trading and a few strategies you can implement to increase your chances of success.
What are the different types of commodities available for trading in India
Now, before we look at how to trade commodities, it is essential to first know the various types that are available for trading.
In India, commodities are classified into two major categories - agricultural commodities and non-agricultural commodities.
Agricultural commodities are products that come from agriculture and livestock farming. It includes cotton, crude palm oil, kapas, mentha oil, soybean, turmeric, ground nut, wheat, and bajra, among others.
Non-agricultural commodities can be further classified into bullion, base metals and energy. The list includes gold, silver, copper, aluminium, steel, crude oil and natural gas, among others.
How is commodity trading in India carried out
Contrary to popular opinion, commodity trading in India is done exclusively through derivative contracts like futures and options.
Commodity futures and options are financial contracts between two parties, where they agree to buy and sell a particular commodity at a predetermined price on a future date. The value of these contracts is directly dependent on the underlying commodity. For example, if the price of the underlying commodity rises, the value of its futures and options contracts will also rise and vice versa.All commodity derivative contracts have an expiration date. Most traders do not hold the derivative contracts until their expiration dates. Instead, they close their positions prematurely after capturing the short-term price movements in the commodity.
Traders who hold onto a commodity derivative contract until its expiration date would be obligated to fulfil the terms of the agreement. For example, if you purchase a commodity futures contract and hold onto it until its expiration date, you would be obligated to purchase the specified quantity of the commodity at the agreed-upon price.
On the contrary, if you sell a commodity futures contract and do not close off your position before the expiration date, you would be obligated to sell the specified quantity of the commodity at the agreed-upon price.
What are the different commodity trading exchanges in India
The commodity derivative contracts are listed and traded on dedicated exchanges. An exchange is an electronic marketplace where traders can freely purchase and sell commodity derivatives between each other. In India, there are five operational exchanges where commodity derivatives are actively traded.
- Bombay Stock Exchange (BSE)
- National Stock Exchange (NSE)
- Multi Commodity Exchange of India (MCX)
- National Commodity and Derivatives Exchange (NCDEX)
- Indian Commodity Exchange (ICEX)
How to trade in the commodity market in India
If you are unsure of how to start commodity trading in India, the step-by-step guide outlined below can help you out.
- Step 1: Understand how the commodity market works
The first step is to familiarise yourself with the basics of commodity trading. Understand how commodities are traded, the various factors that influence commodity prices and the different types of commodities available for trading. - Step 2: Open a commodity trading account
To trade commodities on any of the above-mentioned exchanges, you need to first open a trading account with a stockbroker. When selecting a broker, make sure to look into factors like the services on offer, their charges and the reliability of their trading systems. - Step 3: Deposit funds into your commodity trading account
Once the account is open, you need to transfer some funds into it to begin commodity trading. Since you are a beginner, it is advisable to start slow. Use no more than 5% to 10% of your total available capital during the initial stages. You may consider increasing the amount you invest once you have gained enough experience. - Step 4: Draw a detailed trading plan
A comprehensive strategy that is in line with your financial goals and risk tolerance is crucial for success when trading commodities. When developing a plan, make sure to remember to consider factors like preferred commodities, entry and exit points, position sizing and market sentiment. - Step 5: Execute the plan
Once you have a trading plan in place, the final step is to execute it. When trading, remember to monitor the market closely and make adjustments to your positions if necessary. Also, consider implementing strict risk management practices to protect your capital from downsides due to adverse market movements.
What are some commodity trading strategies that are easy to implement
Here are some easy commodity trading strategies you can consider implementing when you trade.
Trend following strategy
This strategy involves identifying the direction of the prevailing trend in a commodity's price and trading in the direction of that trend. You can use technical indicators like moving averages or trendlines to identify trends and enter positions accordingly.
Breakout trading strategy
The breakout trading strategy involves entering into a suitable position when the price of a commodity breaks above or below a significant support or resistance level. The position you take must match the direction of the breakout.
Seasonal trading strategy
The prices of agricultural commodities tend to fluctuate depending on the progression of seasons. This strategy aims to take advantage of these regular seasonal patterns and involves analysing historical price data to identify trends and enter positions based on expected seasonal price movements.
Conclusion
With this, you must now be aware of how to trade commodities in India. Commodity trading is a good way to profit from the short-term price movements in various agricultural and non-agricultural commodities. If you are planning on trading in this segment in the future, keep in mind that not all commodity derivative contracts have sufficient liquidity. Trading in illiquid contracts can make it hard to enter and exit positions and may even lead to losses, especially if you are not able to close out your trades in time.
