Among the many ways to invest, quite a handful of investors put their money into the commodity market. Not only is it more viable but also provides greater returns when compared to the stock market. So, here is a brief introduction to the infamous commodity market.
However, before learning about the commodity market we need to know a little about commodities, which brings us to the question :
How to invest in the commodity market work?
Exchanges for commodity markets in India
Why should you invest in the commodity market
What are commodities?
Commodities in commerce are basic goods that can be interchanged for something of the same value. They also are defined as naturally occurring materials which can be collected, processed, and refined for human use.
There are popularly split into two types of commodities:
- Hard Commodities: These are commodities that are mined and Extracted from Earth.
Ex.Gold, Natural Gas, Minerals, etc…
- Soft commodities: These are commodities that are harvested from plants and cattle.
Ex. Oil, food, Lumber, Tea, etc…
They are usually mass-produced for standardized quality and quantity.
What is the commodity market?
A commodity market is a place where you buy, sell and trade materials or products, as simple as that.
Generally speaking, a commodity market would refer to a place where buyers and sellers come to trade with immediate physical delivery. It is often referred to as ‘spot markets’ or in simple words, a ‘physical market’ or a ‘cash market’.
Parallel to how the commodities are distinguished there are two types of commodity markets.
However, there is a market for commodities akin to the stock market. It is known as ‘ Futures and options.
They are also called derivatives.
How to invest in the commodity market work?
Commodity markets allow the Producers and Consumers of commodities to gain access to a centralized and liquid marketplace.
Earlier the commodities market Required a considerable amount of time, money, and expertise. Thus, it was limited only to professional traders. Today, it has become much more seamless and hence is accessible to everyone.
In order to invest, you will need a trading account and not just a Demat account.
You can invest in the commodity market through a futures contract or an options contract. Both futures and options are known as derivatives because they derive their value from the underlying asset of the contract and not the contract itself.
When you enter a contract, you essentially agree to buy or sell a certain commodity at a certain point of time in the future at a predetermined price.
Let us understand it better with an example:
Let’s say you are interested in investing in platinum. You enter a futures contract or an options contract through your trading account. Assume that you enter a futures Platinum contract which states you will buy 10 grams of Platinum for 25000 rupees in 3 months.
Now, let us say that you have held the contract until its expiry, then the seller who sold you the contract will have to send 10 grams of platinum for 25000 rupees even if the price of Platinum has risen to 30000 rupees in the three months time. Similarly, you will also have to pay 25000 rupees to the seller if the price of platinum has dropped to 20000 rupees for 10 grams in that period of time.
Thus, you can easily grab a profit or incur a loss in the futures and options trading market.
Exchanges for commodity markets in India
There are 22 exchanges for commodity markets in India under the banner of the forwarding Markets Commission.
There are Four Markets that are extremely popular
1) Indian Commodity Exchange (ICEX)
2) National Multi Commodity Exchange of India (NMCE)
3) Multi Commodity Exchange of India (MCX)
4) National Commodity and Derivative Exchange (NCDEX)
Why should you invest in the commodity market?
1. Diversification
When it comes to returns, commodity markets do a lot better than the stock market. There are many cases where the performance of the commodity market is inverse to the performance of the stock market i.e when the stock prices go down, the commodity prices rise up. Thus, It is a good way to diversify your portfolio in case the stock market crashes down. However, it is not the case for all shares and commodities. There are several cases where the commodity market runs parallel to the stock market and even higher.
2. Real Returns
There are certain goods that remain stable irrespective of the economic and market conditions but some are extremely volatile. A good example of a highly volatile commodity is crude oil. The price of crude oil is extremely unstable due to the fluctuations in supply, economic conditions, and sometimes mining issues.
At the same time, Commodity traders profit from promising large investments in the future and help the speculators to earn more money.
3. Margin Trading
In comparison to stop or bond commodity traders of a very low margin of trading. It allows brokers to trade on borrowed funds and thus giving larger returns to investors with each transaction.
As one of the many investments that could be made online commodity markets also have huge potential when it comes to trading in a lucrative fashion. It serves as a good way to diversify your portfolio and at the same time balance it.
Please remember if you hold your futures or options contract till the date of expiring it will settle the contract mandatorily through the delivery. If you do not wish to receive the delivery, make sure you close all the open positions well in advance of the date of expiry.
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