How To Trade Commodiites- For Beginners

Do you think that gold prices will touch 35,000 in days to come?

or Crude Oil prices will move below 20$ as predicted by some investment banks and rating agencies?

or Prices of Lead will see a strong upward trend in days to come?

If you believe any or some of such prediction may come true in future and you wish to bet on it and make some money out it then welcome to commodity futures market. In our previous post How to trade in Futures, we learnt about stock futures. In this post lets try to learn about the Commodity Market.

Also Read: The Indian Banking Crises is Just Beginning

 Why commodities trading?

Suppose you have got some free cash to invest and you think that price of gold will go upwards in days to come. So, Investing in Gold can be a good option for you.

You may buy gold coins, biscuits, ornaments or in other form and store them in your home and sell them later when prices go up and make profit out of it.
But in all this, you have to take care of few things like ensuring that the gold you buy is pure, storing it in a safe place, ensuring its safety and security, transport it to vault and other such hassles.
In order to avoid above hassles and problems a far better way to invest in gold would be to buy gold futures from the commodities exchange.
How do you do that?

When you buy a Gold Futures contract, you undertake to do three things.
1. Purchase the amount of gold mentioned in the contract.

2. Purchase it at the price mentioned in the contract.

3. Purchase it on the expiry of the contract. The expiry could be after one month, two months, three months and so on. Of course, if you sell the Gold Futures contract before it expires, then you don't have to worry about actually buying the gold.
Suppose you buy the Gold Future contract at say Rs 27,000 per 10 gm.
Your prediction comes true and the gold prices rally to Rs 28,000 per 10 gm.
You can sell the Gold Futures any time before expiry of the contract.
Gold and other commodity futures prices are quoted on the commodity exchanges in exactly the same way in which stock prices or stock futures prices are quoted on a daily basis in the stock markets.
How it works

Just like stock futures (Read How to trade in Futures to understand how futures work). 
In case of stock futures you don't pay entire amount for buying a lot you pay margin amount, which is a small percentage of total amount. In same way in commodity futures you pay a margin to buy the contract.
Let's say you are buying a Gold Futures contract. The minimum contract size for a gold future let's say is 1 kg. 1 kg of gold may be worth Rs 27,00,000.
The margin for gold set by MCX is 5.38%. So you only end up paying around Rs 1.5 Lakhs instead of 27 Lakhs
The low margin means that you can buy futures representing a large amount of gold by paying only a fraction of the price.
So you bought the Gold Futures contract when it was Rs 27,00,000 per 1000 gms.
The next day, the price of gold rose to Rs 27,20,000 per 100 gms.
Rs 20,000 (Rs 27,20,000 –-Rs 27,00,000) will be credited to your account.
The following day, the price dips to Rs 27,10,000.
Rs 10000 will get debited from your account (Rs 27,20,000 - Rs 27,10,000).

Remember here your investment here will still be 1.5 Lakhs which you paid as margin but the gains or losses are realized as if you are holding the entire 27 Lakhs worth of gold with you.
What you need to know

Compared to stocks, trading in commodities is much cheaper, because margins are much lower than in stock futures.  Thus, commodity futures are a speculator's paradise.
If you are a professional trader and do not really care what you trade, then commodity futures could be another asset class that you would be interested in.
The advantages in this line is that there are no balance sheets, no complicated financial statements----all you have to do is follow the supply and demand position of the commodities you trade in very closely.
But, it would be wise to avoid commodity trading if you are a beginner. A better move would be to initially trade in stock futures before opting for commodity futures.

Also Read: How To Trade Options For Beginners

Happy Trading
The Multiplier

Suggested Reads For Commodity Trading


2)  Guide to Indian Commodity Market by Ankit Gala & Jitendra Gala

Product Details

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