How commodity trading can make you rich

Image: Trading in commodities is just as risky as trading in the stock market.
Photographs: Dominic Xavier

For a lot of people, trading in commodities is as good as trading in the stock markets.

It has the same amount of uncertainties and risks associated with it. You can also make the same amount of profit, if not more, from it.

Knowing the basics of commodity trading, however, is essential before you dabble in its nitty-gritty.

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How commodity trading can make you rich

Image: Commodities are bought and sold in standardised contracts.
Photographs: Rediff Archives

What is commodity trading?

Commodity markets are markets where physical raw or primary products such as gold, agricultural products, precious and base metals, energy commodities, etc, are exchanged.

These raw commodities are traded on regulated commodities exchanges such as National Commodity and Derivatives Exchange Limited and Multi Commodity Exchange of India, in which they are bought and sold in standardised contracts.

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How commodity trading can make you rich

Image: The commodity market is a promising avenue for your investment.
Photographs: Dominic Xavier

Why should you opt for commodity trading?

The commodity market is a promising avenue for your investment. It offers huge opportunities and enables you to diversify your portfolio.

With the least margin requirement being as low as Rs 5,000, it is suited for small investments also.

It also enables you to have more control over the costs associated with trading. For example, if you have traded in gold as a long term investment, there might have been times when you would have been worried about the protection, transportation and purity of the gold you are investing in.

With commodity trading, you can deal in gold futures where, just like stock futures, you do not have to actually buy the gold and keep it somewhere. Instead, by buying gold futures, you can eliminate the need to worry about these things and concentrate on maximising your profits.

The potential for attractive returns is probably the most obvious reason to go in for commodity trading, but it isn't the only factor.

Commodities also offer investors other significant benefits, including enhanced portfolio diversification and a hedge against inflation and event risk.

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How commodity trading can make you rich

Image: Commodities can be traded on either spot markets, or in the form of futures.
Photographs: Dominic Xavier

What are commodity futures?

Commodities can be traded on either spot markets, or in the form of futures.

Spot markets are those in which the commodity is traded immediately in exchange for cash or some other goods.

Futures are standardised contracts among buyers and sellers of commodities that specify the amount of a commodity, grade/quality and delivery location.

Commodity trading with futures contracts takes place at a futures exchange and, like the stock market, is entirely anonymous.

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How commodity trading can make you rich

Image: Gold bullion coins pictured in the mint
Photographs: Siphiwe Sibeko/Reuters

How does the trading work?

Commodity trading works exactly like stock futures. When you buy a 'futures,' you don't have to pay the entire amount, just a fixed percentage of the cost. This is known as the margin.

For example: You decide to buy 100gms of gold futures (which is the minimum contract size) for a certain price. You have to pay a certain amount of margin set by the commodity trading exchange you are trading on, which would be a lower amount than the original price for 100 gms.

The next day, the price goes up by Rs. 1000. Rs. 1000 would be credited into your account. The following day, it dips by Rs. 500. Rs. 500 is debited from your account.

Once you feel that the amount that you have already profited with is not going to change, you can choose to sell the futures. This is simplest way to explain commodity futures trading.

What are the dos and don'ts of commodity trading?

Dos

Don'ts

Trade only through registered members
Familiarise yourself with the guidelines and rules, regulations, byelaws, circulars, etc, of the trading exchange
Take an informed decision
Understand the delivery and settlement procedure
Understand and comply with taxation and other relevant laws
Pay all applicable margins. Collect/pay market-to-market margins on a daily basis
Insist on documentation with the member such as a member client agreement, and know your client
Read and understand the risk disclosure document
Insist on signed contract notes containing all relevant information such as member registration number, order details, trade rate, quantity, etc.
Obtain receipt for collateral deposited with the members
Insist on a periodical statement of your ledger account
Freeze your demat account in case of a long absence

Don't get misled by rumours, luring advertisements and promises and a bull/bear run of market sentiments
Don't trade any contract without knowing the associated risks
Don't undertake off-market transactions
Don't accept/pay cash in futures trading
Don't sign blank delivery instruction slips
Don't delay payment/deliveries to members

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