A Guide to Commodity Trading in India

Commodity trading is an exciting segment of financial markets that many traders in India are unaware of. While Indian equity markets operate from 9:15 a.m. to 3:30 p.m., the commodity market offers extended trading hours from 9:00 a.m. to 11:30 p.m., divided into two sessions. This is especially beneficial for working professionals who can trade after office hours. However, entering this market requires a clear understanding of its dynamics, benefits, and risks. In this article, we dive into everything you need to know about commodity trading in India.

What is Commodity Trading?

Commodity trading involves buying and selling commodities, such as natural resources or agricultural products, on exchanges. This can include energy sources like crude oil and natural gas, metals such as gold and silver, and agricultural products like wheat and cotton. The primary goal in commodity trading is to profit from fluctuations in the price of these commodities.

Why Does Commodity Trading Exist?

Unlike equity markets that exist for companies to raise funds, the commodity market primarily serves to allow businesses to hedge against price fluctuations. For example, consider a gold shop owner named Charlie. He holds 10 kg of gold, hoping to profit from making jewellery. If the price of gold falls significantly from ₹80,000 per 10g to ₹60,000, Charlie may incur losses that outweigh his profits from jewellery sales. But if the price of gold goes way up (say ₹1 lakh per 10g), he might earn more, but it will also cost him more to restock. Thus, commodity trading allows Charlie to hedge his risk by using futures contracts to balance potential losses or gains.

[A futures contract is an agreement to buy or sell something (like gold, oil, or stocks) at a fixed price on a future date. It helps buyers and sellers protect themselves from price changes—buyers lock in lower prices if they expect a rise, while sellers secure higher prices if they expect a drop.]

How to Get Started in Commodity Trading in India?

To begin trading commodities, you need to understand the basics, including the types of commodities available, how trading works, and the exchanges involved.

In India, there are two primary exchanges for commodity trading:

• National Commodity & Derivatives Exchange Ltd (NCDEX): This platform primarily deals with agro-based commodities like wheat, spices, and cotton.
• Multi Commodity Exchange (MCX): This is where non-agro commodities like gold, silver, zinc, and crude oil are traded.

Both exchanges are regulated and provide a safe environment for trading. It is crucial to avoid unregulated platforms or apps that do not adhere to SEBI guidelines!

All major brokers in India like Zerodha, Upstox, Fyers, etc. support commodities trading. You should activate the commodities segment separately in your broker/trading account.

Types of Contracts

Commodity trading mainly involves derivatives, specifically futures and options:

• Futures Contracts: Agreements to buy or sell a commodity at a future date at a predetermined price.
• Options Contracts: Rights to buy or sell a commodity at a specific price before a set date.

Unlike stocks, commodities can't be held forever. Every futures or options contract has an expiry (settlement) date. As a thumb rule, never let your commodity trades enter into a settlement phase. It's better to square off your positions at least 2-3 days before the settlement date.

Popular Commodities and Contracts

Some of the most actively traded commodities include:

• Gold: Available in various contract sizes, including 1 kg, 100 g, and 8 g.
• Silver: Typically traded in contracts of 30 kg or smaller sizes.
• Crude Oil: A significant commodity often influenced by global market conditions.
• Natural Gas: Another volatile commodity that attracts traders.

The capital needed to trade commodities depends on the type of commodity and the broker's policies. Brokers often have specific margin requirements for commodities.

Commodity trading offers high leverage. For example, a gold mini contract worth ₹7.2 lakh may only require ₹72,000 as margin. Leverage amplifies both profits and losses, so it's essential to have proper risk management strategies in place!

Commodity Indices in India

Similar to equity indices like Nifty50, commodity markets also offer indices for trading:

1. Bullion Index: Tracks gold and silver prices.
2. Metal Index: Tracks aluminium, copper, lead, zinc, and nickel prices.
3. Energy Index: Tracks crude oil and natural gas prices.

These indices allow traders to speculate on overall market movements rather than individual commodities.

Advantages of Commodity Trading

Commodity trading offers several benefits that can attract both individual and institutional traders:

• High Liquidity: Many commodities, especially gold and crude oil, have high trading volumes. These markets tend to follow price action well.
• People who are unable to trade during the daytime (office-goers) can use the opportunity to make potential extra income!
• Less Price Manipulation: Commodities are traded globally, reducing the chances of price manipulation compared to more localised markets.
• Hedging Opportunities: Businesses can hedge against price fluctuations to stabilise costs and revenues.

Disadvantages of Commodity Trading

While there are many advantages, there are also significant risks and drawbacks to consider:

• High Price Volatility: Commodity prices can change rapidly due to geopolitical factors or supply and demand shifts, which may result in substantial losses for unprepared traders.
• Leverage Risks: Trading with leverage can amplify losses. Commodity traders must understand how to manage leverage effectively.
• Liquidity Issues: Not all contracts have the same level of liquidity, which can complicate trades and lead to slippage.
• Geopolitical Sensitivity: Commodity markets are often the first to react to global events, requiring traders to stay informed about international affairs.

Conclusion

Commodity trading presents a unique opportunity for investors looking to diversify their portfolios and take advantage of market fluctuations. Also, profits from commodity trading are treated as business income (same as F&O). You'll have to pay tax based on your tax slab.

Approach the commodities market only after a thorough understanding of the risks involved, the mechanics of trading, and the specific commodities you wish to trade. Always start small, educate yourself continuously, and consider consulting with financial advisors to navigate the commodities market effectively.

As you venture into commodity trading, remember to keep your capital allocation conservative, especially if you're new to the field. With the right strategies and knowledge, you can successfully navigate the volatile waters of commodity trading and potentially achieve significant returns. Happy trading!