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Download Free PDF. Commodities Trading in India. Yepuru Naidu. Download PDF. A short summary of this paper. For those who want to diversify their portfolios beyond shares, bonds and real estate, commodities are the best option. Till some months ago, this wouldn't have made sense.
For retail investors could have done very little to actually invest in commodities such as gold and silver -- or oilseeds in the futures market. This was nearly impossible in commodities except for gold and silver as there was practically no retail avenue for punting in commodities.
However, with the setting up of three multi-commodity exchanges in the country, retail investors can now trade in commodity futures without having physical stocks! Commodities actually offer immense potential to become a separate asset class for market-savvy investors, arbitrageurs and speculators. Retail investors, who claim to understand the equity markets may find commodities an unfathomable market.
But commodities are easy to understand as far as fundamentals of demand and supply are concerned. Retail investors should understand the risks and advantages of trading in commodities futures before taking a leap. Historically, pricing in commodities futures has been less volatile compared with equity and bonds, thus providing an efficient portfolio diversification option.
In fact, the size of the commodities markets in India is also quite significant. Currently, the various commodities across the country clock an annual turnover of Rs 1,40, crore Rs 1, billion. With the introduction of futures trading, the size of the commodities market grow many folds here on. Like any other market, the one for commodity futures plays a valuable role in information pooling and risk sharing. The market mediates between buyers and sellers of commodities, and facilitates decisions related to storage and consumption of commodities.
In the process, they make the underlying market more liquid This book should help the reader to understand the basics of commodities trading system in India. It will also introduce the reader with different terminologies, trading procedures, various commodities, futures trading and so on, which are available to trade in India. Before trading in these commodities, you should have thorough knowledge about the fundamentals of each of these commodities and how and what are the factors affect their demand and prices.
It is ideal for traders and investors who wish to diversify their portfolio beyond stocks, bonds, mutual funds and real estate. Besides the retail investors do not require to physically own the commodities they are trading in. Commodities have potential to become a distinct asset class for skillful investors and traders.
Understanding commodities is relatively simple for investors as they are more align with the basic fundamental economics of demand and supply. However retail investors should understand the risks associated with commodities trading before investing in this new asset class. Historically, commodity prices have been less volatile compared to equities, thus can be a good diversification option. In the process, they make the underlying market more liquid. All the three have electronic trading and settlement systems and a national presence.
But before we begin trading in commodities, let us first understand the basic market structure and mechanism. Commodities market like stock market works in spot or cash market and futures market. Spot market Market where commodities are bought and sold in physical form by paying cash is a spot market. The price on which commodities are traded in this market is called spot price.
For example, if you are a farmer or dealer of Chana and you have physical holding of 10 kg of Chana with you which you want to sell in the market. You can do so by selling your holdings in either of the three commodities exchanges in India in spot market at the existing market or spot price. Futures Market The market where the commodities are bought and sold by entering into a contract to settle the transaction at some future date and at a specific price is called futures market.
The unique feature of futures market is that you do not have to actually hold the commodities in physical form or for that matter take the delivery in physical form. Every transaction is settled on cash basis. As you are aware the prices in the spot market are volatile and are always fluctuating.
And as a trader or investor, you would want to eliminate or at least minimize your exposure to such price risk. Hence you can use futures market to settle your contract. For example, the current spot price of Gold is Rs per 10 grams.
Hence you enter into gold futures contract with a futures price of Rs the price at which the futures contract is currently being traded in futures market with an expiry date the date on which the futures contract will be settled at futures price of 1 month from now.
Hence you will make a profit if the spot or market price of gold is more than Rs on the settlement date or the expiry date of your futures contract. Futures contract are standardized contracts made by the commodities exchange and come with specific set of prices with minimum lot size to trade and with a specific expiry or settlement date. Let us look at each of these terminologies and how are they used in a futures contract.
Similarly in commodities futures contract or for that matter in any futures contract, there is a minimum specified limit in terms of contract size to be traded in a contract. For example gms is the lot size for GOLD futures contract on National Commodities Exchange of India, where if you want to trade, you need to enter into futures contract of minimum gms. So at a time there can be more than 1, 2 or 3 contract months of the same commodity for which, the price might be quoted for trading with different delivery months.
They provide all the basic services like research reports, daily price updates, trading information, news and other information that will help their clients to enter into a transaction. Basically they smoothen the entire trading process for the clients. Besides the commodity Brokers there are other participants whose purpose to trade in the futures market could be quite interesting to know for all those who intend to participate in the Futures market.
They can be broadly classified into two main categories. First, the profit seekers who want to benefit from the price fluctuations in the commodities with sole purpose of making money. People like investors, traders, speculators and portfolio or hedge fund managers. While the others are know as Hedgers In order to hedge something, one needs to physically own it or is contemplating to buy and take a physical delivery.
The hedgers are basically people how actually own the commodities in physical form with them. These are the people who are worried about the potential losses they could incur due to volatile prices of the commodities they could be physically holding with them. They trade in the futures market to transfer their risk of movement in prices of the commodity they are actually physically dealing.
Margin System Futures market work on system called as Margin System Margin is good faith deposit money that has to be kept with a registered Member of the exchange they can be clearing member, trading cum clearing Member, register broker or any other category of membership of the exchange who are permitted to accept orders for the clients , in order to initiate or be eligible for trading in commodity futures. The Member in turn has to maintain a MARGIN ACCOUNT with the Exchange besides keeping a security Deposit with the clearing house of the Exchange While the exchange takes care of the smooth and orderly execution of the trades, the clearinghouse acts as the third party entity to ensure and guarantee all the trades done on the exchange floor or the electronic platform.
So trader need not have to directly deal with another trader, the clearing corporation takes the role of the buyer for every seller and the role of the seller fro every buyer. In order to see and guarantee the financial fulfillment of the trade, it takes margin deposit from both the buyer and seller before allowing them to trade.
While the Exchanges establish the rules for trading, the FMC establishes the regulations for controlling the functioning of these commodities futures markets. So when a trader wants to trade in commodities worth say 25,00, then he need not have to invest that much. Things to know before your first futures trade Since Futures Contract are contracted for a future date, it is important know where the spot market is, before you can make your analysis of what the futures price might be at the time of delivery, to arrive at a reasonable level to buy or sell.
While an Hedger would be just making his calculation to arrive at the price protection level and the quantity that has to hedged. The spot prices of various commodities that are permitted for futures trading are available at various private and Government Sponsored web sites. We are in synergy with institutes to get the real time spot market prices on our web site very soon.
You can also get some fundamental news about the markets and of the commodity of your choice in leading newspapers or other web-news agencies.
This entails costs, Benefits, or both to the potential deliverer. Also the actual difference between the futures price and the spot price traded on a particular day is called as the BASIS for that particular contract month of the commodity.
However it is not necessary in all cases. For most storable commodity the difference between the spot price traded on a particular day is positive and as the contract month keeps coming nearer to the expiry date, it goes on decreasing and finally on the day of the delivery, the Future Price is nearly the same as the spot price.
The initial preparation would involve like getting to know which commodities are traded on which exchanges, who are registered members, what are the delivery months for those commodities, what are the margin requirements, what is the volume of activity on those commodities, etc. Assuming that the delivery period for the contract is from 1st to 15th of the Delivery Month. Avoid taking fresh positions in such contracts.
Instead go for the next immediate contract month that is June. Having sold in the market, we will have to wait for the market to gives us a lower level to buy back the contract before the delivery date in June. The obligation to take delivery by a BUYER can be removed by selling back the contract before the delivery period. There is no carry forward cost involved. Be it stocks, bonds, gold or any other asset or commodity. Most of the people just get carried away by seeing increasing number of volumes in trade turnover or by seeing a sudden jump in prices.
The first rule of trading in the commodities market is to think from your brains and not with your heart! Second, whenever you do not understand the logic or reason behind sudden change in the price of gold, stay out of trading. Third, understand the news in totality. Not all the news affects the gold price equally and not all bad news are actually bad for gold trading.
However, effective technical analysis allows us to use trends, patterns and other indicators to evaluate the market's current psychological state. It takes a disciplined trader to be able to watch and listen to the market doing one thing, filter out the noise, then do the opposite - all in a controlled manor.
There are two types of traders: 1. Herd Mentality Trader - Someone who trades off fear and greed buying near tops and panic selling out at the bottom with the masses. Basically his trading pattern replicates most of the other participants in the market. Black Sheep Trader - A trader who stand apart from the masses and trades opposite to the "herd" during extreme levels. Market Psychology Trading Conclusion: Most get involved with the market because it looks like something they can quickly learn and start making money from home.
But it doesn't take long before they quickly realize there is more to trading than meets the eye. While trading looks easy from a glance, in actuality I think its one of the toughest jobs out there. Well, this is what you are up against: 1. You are trying to predict something that is unpredictable 2. You are trading against automated computers with complex algorithms 4. You are trading with your hard earned money which causes fear and greed 5. You must accept losing trades as that is part of the business 6.
You must trade with a proven trading strategy and follow the system 7. You must understand money management and apply it to every trade 8. You must truly love the market cause it will break you down mentally I don't want to say you must be a contrarian, but in reality you must do the opposite of the masses during times of extreme price behavior.
These extremes happen on a daily basis when trading intraday charts and every weeks when looking at daily charts. The toughest part is to pull the trigger when emotions are flying high in the market and you are looking to do the opposite. It takes several trades before you even start to get comfortable doing this. Reward and risk are always related. It is unrealistic to expect to be able to earn above-average investment returns without taking above-average risks as well.
Most people are naturally risk averse. Commodity trading has the reputation of being a highly risky endeavor. It is true that a high percentage of traders eventually lose money. Many people have lost substantial sums. Commodity trading is the same in the sense that the individual is the one who decides how he wants to operate.
He can make large bets or small ones. One can trade commodities carefully and risk as little as Rs or Rs on a trade. You could trade a long time this way and only lose a few thousands. However, most people are not that patient. The unfortunates who lose big are those who can't control themselves. They take big risks in an attempt to get rich quick. Another way to lose big is blindly to turn your money over to others to trade such as brokers or money managers.
Anyone who is going to try speculation should be fully aware of and be comfortable with the risks involved. Managing the risks of trading is a very important part of any trader's success. Although the risks can be managed, they can never be eliminated. Remember that the high returns successful speculators can earn are available only because the speculator is being paid to take risk away from others. When a commodity trader buys a futures contract, he will lose if the price declines.
His risk is theoretically limited only by the price of the commodity going to zero. If he sells, he will lose if the price goes up. The risk is theoretically unlimited because there is no absolute ceiling on how high the price of the commodity can go.
You will lose your money if the price falls below Rs , till you either exit out of the contract or till the expiry of the contract. In practice, however, the trader can offset his position when the trade is going against him to limit his loss. While a prudent trader always has a plan to limit his losses when trades don't work, it is not possible to guarantee a particular loss limit amount.
As a practical matter, however, you can usually limit losses to within a few thousand rupees of an intended amount. Very often losses are within Rs of the amount you project.
Only when very unusual things happen suddenly can losses balloon to thousands of rupees more than you expected. Other kinds of surprise situations that can cause unpredicted losses are freezes, floods, droughts, government currency interventions and crop reports.
With attention and foresight a trader can sidestep these risky situations. The best way to control unpredictable risks is to trade conservatively so larger-than- expected losses are still only a small percentage of the total account.
Another thing to understand about risk in trading is that you cannot avoid losses by careful planning or brilliant strategy. Numerous losses are part of the process. Trading is a business of making and losing money.
Any trade, no matter how well thought out, has a chance of becoming a loser. This is absolutely not true. The best traders lose a lot of money, but they eventually make even more over time. There is no point trading commodities if you cannot handle the psychological discomfort of making losing trades. While people tend to take losses personally as a sign of failure, good traders shrug them off. The best trading plans result in many losses. Because of the amount of randomness in market price action, such losses are inevitable.
Some of them also offer trading through Internet just like the way they offer equities. You can also get a list of more members from the respective exchanges and decide upon the broker you want to choose from.
What is the minimum investment needed? You can have an amount as low as Rs 5, All you need is money for margins payable upfront to exchanges through brokers. The margins range from per cent of the value of the commodity contract. While you can start off trading at Rs 5, with ISJ Commtrade other brokers have different packages for clients. For trading in bullion, that is, gold and silver, the minimum amount required is Rs and Rs for on the current price of approximately Rs 65,00 for gold for one trading unit 10 gm and about Rs 9, for silver one kg.
The prices and trading lots in agricultural commodities vary from exchange to exchange in kg, quintals or tonnes , but again the minimum funds required to begin will be approximately Rs 5, Do I have to give delivery or settle in cash?
You can do both. All the exchanges have both systems - cash and delivery mechanisms. The choice is yours. If you want your contract to be cash settled, you have to indicate at the time of placing the order that you don't intend to deliver the item. If you plan to take or make delivery, you need to have the required warehouse receipts. The option to settle in cash or through delivery can be changed as many times as one wants till the last day of the expiry of the contract. What do I need to start trading in commodity futures?
As of now you will need only one bank account. What are the other requirements at broker level? You will have to enter into a normal account agreements with the broker. These include the procedure of the Know Your Client format that exist in equity trading and terms of conditions of the exchanges and broker.
Besides you will need to give you details such as PAN no. What are the brokerage and transaction charges? The brokerage will be different for different commodities. It will also differ based on trading transactions and delivery transactions.
In case of a contract resulting in delivery, the brokerage can be 0. The brokerage cannot exceed the maximum limit specified by the exchanges. Where do I look for information on commodities? Daily financial newspapers carry spot prices and relevant news and articles on most commodities. Besides, there are specialised magazines on agricultural commodities and metals available for subscription. Brokers also provide research and analysis support. But the information easiest to access is from websites.
Though many websites are subscription-based, a few also offer information for free. You can surf the web and narrow down you search. Who is the regulator? The exchanges are regulated by the Forward Markets Commission. Unlike the equity markets, brokers don't need to register themselves with the regulator.
The FMC deals with exchange administration and will seek to inspect the books of brokers only if foul practices are suspected or if the exchanges themselves fail to take action. In a sense, therefore, the commodity exchanges are more self-regulating than stock exchanges.
But this could change if retail participation in commodities grows substantially. Who are the players in commodity derivatives? The commodities market will have three broad categories of market participants apart from brokers and the exchange administration - hedgers, speculators and arbitrageurs.
Brokers will intermediate, facilitating hedgers and speculators. Hedgers are essentially players with an underlying risk in a commodity - they may be either producers or consumers who want to transfer the price-risk onto the market. Producer-hedgers are those who want to mitigate the risk of prices declining by the time they actually produce their commodity for sale in the market; consumer hedgers would want to do the opposite.
For example, if you are a jewellery company with export orders at fixed prices, you might want to buy gold futures to lock into current prices. Investors and traders wanting to benefit or profit from price variations are essentially speculators. They serve as counterparties to hedgers and accept the risk offered by the hedgers in a bid to gain from favourable price changes.
What happens if there is any default? The exchanges have a penalty clause in case of any default by any member.
There is also a separate arbitration panel of exchanges. In case of delivery, the margin during the delivery period increases to per cent of the contract value.
Is stamp duty levied in commodity contracts? What are the stamp duty rates? As of now, there is no stamp duty applicable for commodity futures that have contract notes generated in electronic form. However, in case of delivery, the stamp duty will be applicable according to the prescribed laws of the state the investor trades in.
This is applicable in similar fashion as in stock market. How much margin is applicable in the commodities market? As in stocks, in commodities also the margin is calculated by value at risk VaR system.
Normally it is between 5 per cent and 10 per cent of the contract value. The margin is different for each commodity. Just like in equities, in commodities also there is a system of initial margin and mark-to-market margin.
The margin keeps changing depending on the change in price and volatility. Are there circuit filters? Yes the exchanges have circuit filters in place. The filters vary from commodity to commodity but the maximum individual commodity circuit filter is 6 per cent. The price of any commodity that fluctuates either way beyond its limit will immediately call for circuit breaker. Since the development of the financial markets, investors have lost tough with this wonderful asset called gold, which they now only acts as an asset of last resort.
However, in recent years gold has tremendous demand and interest from investors around the globe. While this outreached rally in recent price of gold is obviously suggesting that demand surpassed the supply, which is clearly a positive factor, there are many reasons why people and institutions around the world are once again investing in gold. Let us look at what are the fundamental reasons behind interest in gold as an investment. Fundamentals behind Gold price movements 1 Supply and Demand.
The ultimate negotiator of any price is supply and demand. When demand exceeds supply, prices rise and vice versa. In case of gold, its global demand is growing much faster than its global mined supply, so the only possible economic resolution to fix this imbalance is for the price to rise to the extent where demand equals supply.
This means that the price at which now gold trades is the maximum price investors are will to pay to buy gold. Unlike almost every other business, gold mining is totally dependent on highly local geology. Since gold is so scarce in the natural world, it is very difficult to find a site with enough gold to mine economically. Global gold mined supply is therefore very inelastic unresponsive to price. Looking at the complex gold mining and producing structure, it is not unlikely to see gold demand far exceeding supply for many more years to come.
The general stock markets move in great year cycles known as Long Valuation Waves. Although stocks make horrible long-term investments during the latter half of these Long Valuation Waves, thankfully commodities and hard assets flourish. Commodities also move in roughly one-third-of-a-century cycles over time, but they tend to swing degrees out of phase to the equity valuation waves. Our current commodities bull launched in , just after the secular top in the general stock markets capping a mighty equity bull lasting for half of a year valuation cycle.
Market history is very emphatic in demonstrating that the 17 years after this parallel commodities bottom and equities top should be great for commodities but very poor for equities. Since we are now about 7 years into this usually year trend, this precedent suggests commodities should be strong and equities weak for another decade or so yet.
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Share Subscribe. Manage Subscriptions. Your Email Address. Agriculture has always been at the mercy of the mother of nature as the most influential element is nothing other than the weather. Droughts, floods and other severe weather conditions can influence the quality of crops or completely ruin the harvest. That is why almost all agricultural commodity traders monitor weather forecasts to more precisely forecast the next crop yield.
The need for more corn, soybeans, wheat, rice etc. According to the former White House Press Secretary Sean Spicer, global food demand is expected to increase by 50 to 97 percent by With this in mind, take into consideration that more and more people are migrating from rural to urban areas where they earn more income.
If there were no other fundamentals there is the "if" again In respect to elements that can drive the agricultural prices down, we have to mention high-tech innovations. It is also good to look out for any government programs or grants for agriculture developments that could be implemented to boost agriculture in the country e.
Farm Bill Programs. Crude oil, or the black gold, is the most popular commodity out there. It is the major source of fuel and energy for the world that is used across all major industries. The most typical products are: gasoline used to fuel cars , heating oil, diesel fuel and propane. If you thought you use crude oil just when you are fueling your car, let me set you straight.
As a petrochemical product, it is commonly used when making plastics, isolations, paint, cleaners, lubricants e. There is no end to the list of things in which crude oil is being used.
The former is extracted from oil fields in the North Sea while the latter comes primarily from Texas, Louisiana and North Dakota. Yes, we are talking about the bittersweet-flavoured commodity, coffee. The consumption of this commodity has been increasing over the last few decades and the statistics state that people drink around 2.
Coffee beans can be grown only in subtropical regions at high altitudes, so it might not come as a surprise that the biggest coffee exporters are Brazil and Vietnam.
When predicting the future price of coffee, we should focus mainly on these fundamentals: weather forecasts, political tension in exporting countries, reports proving that coffee has a negative impact on the human body. Coffee is greatly dependent on export, oil prices, therefore, play also a huge role in the prices of coffee. Gold has been throughout human history the definition of wealth providing the highest status in society.
The ancient Egyptians knew that already 3 B. Gold is today the most traded precious metal in the world that is no longer used just for jewellery. It has a wide application in dentistry, aerospace and most importantly in the manufacture of electronics. Unfortunately, gold is nearly ever recycled from electronic devices and given the fact that roughly one billion cell phones are produced each year, there is a good amount of gold that is lost forever.
So, while the demand for gold is relatively still the same, the supply lowers as there are not many more massive gold mines being discovered. To demonstrate how easy it is to open CFD trades on commodities we chose a popular trading platform Plus For our trade example, we selected Brent Oil, one of the most popular commodities out there.
The trade returns and losses are therefore multiplied by ten. In the shown trade example, we chose to buy CFD on 10 barrels of Brent oil. From this amount, we have to deduct the spread fee, which is in our case 0. To make futures trading more transparent, every big player in the game has to report opened positions on commodities, metals and forex.
COT or Commitments of Traders report aggregates all these positions and provide us with very handy data which we can use when trading commodities. That means during the weekend, most commodity speculators analyse data from the COT report, so they would be ready for the next commodity trading week.
The COT report provides data about all long and short positions that the following 3 main groups of commodity traders have taken:. The most important group to focus on are commercials. They are the ones that know the market in and out and know when the commodity is expensive or cheap. Commercials usually hold the biggest positions and the two other commodity trader groups tend to follow them.
Unlike the two other groups, hedgers have the interest to physically own the commodity they trade. The second most important groups are non-commercials e. After commercials, they hold the biggest positions. They are considered to be less knowledgeable than the first group of traders. The last group of traders — Non-reportable are small players that are regarded as the least experienced in the market. It is not recommended to copy their positions. As you can see there are a lot of numbers and navigation in the report is not particularly easy.
After staring in the table for a while you will, however, be able to find how many short and long positions traders have taken or what is the open interest rate number of contracts that have not been settled.
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