When talking of exchange, stock exchange comes first to everyone’s mind. Place where securities (shares, bonds etc.) are traded.
But very few know that commodity exchanges (though in a crude form) existed much before stock markets came into existence. People traded in rare seashells, animals, precious metals, precious stones, pearls, cocoa, soya beans, spices and later on in oil, energy, electronic and electrical equipment, machinery, pharmaceuticals, chemicals, and what not.
Share market deals, more or less with companies producing finished goods, commodity market deals with raw material used to make other products. It can be agricultural like wheat, soya beans, tea, coffee, corn, cotton, sugar etc, can be metals like gold, silver, platinum, palladium, lead, zinc, tin aluminum etc, can be energy like crude oil, natural gas, propane, heating oil, etc. can be livestock and meat like live cattle lean hogs, pork etc, others products are rubber, wool, amber, etc.
Every country has its own measurement criterion and different qualities. So things have to be standardized for smooth exchange of business. In a commodity exchange, the unit of trading is a metric ton, bales, bushels, the barrel of oil, troy ounce, kilogram etc and quantity of each commodity is also defined. Currency is mostly US Dollars.
There are many commodities exchanges in the world. Some have merged and some were unable to continue their business. There are few commodities exchanges that deal in few selected commodities, whereas others deal only in one group of a commodity.
Few known commodity exchanges in India are ICEX (Energy, Precious Metals, Base Metals, Agricultural), MCX (Precious Metals, Base Metals, Energy, Agricultural), NCDEX (Agricultural , Precious Metals, Base Metals, Energy,), NMCE (Precious Metals, Base Metals, Agricultural), COC (Agricultural), ACE (Agricultural), BOOE (Agricultural), UCX (Agricultural), and NSEL.
Bases of trading in commodity market.
- Investment amount – It should be very clear that commodity trading is a risky business. One can multiply his wealth several times and may also wash out his capital with huge debts. Hence one should be very sure of the amount he is investing (usually 10% of your portfolio)
- Brokerage account – You will have to open the brokerage account with any of the brokering firms which deal with the trading of the commodity. You will have to deposit amount in proportion to your trading. Since trading in certain commodities, you have to deposit huge amount because of the minimum trading size of the lot.
- Types of commodities you wish to trade – From the above-given commodities you will have to select which types of the commodity you wish to trade in, like agricultural, precious metals, base metals, energy etc.
- Portfolio diversification – To reduce the risk it is better to diversify your portfolio holding. Say if agriculture is your portfolio you can diversify into wheat, cotton, sugar etc, as our country’s agriculture and crop pattern are based on monsoon, it is seen that monsoon pattern is very uneven in different parts of the country. So for some commodity, there will be an abundance of stock which in turn will be least profitable and vice versa. One should rebalance his portfolio from time to time especially depending on monsoon conditions during that year.
- Other methods – One also can go in for shares of companies which deal in the commodity. But bear in mind that these commodities-related shares will not be in complete relation to rising or fall of the commodity prices over a period of short time. But they will, however, reduce your risk as they will be managed by experts in the commodity field.