uTrade Algos
Commodity trading deals with the trading of tangible items in the commodity market. If you’re a beginner looking to learn about commodity trading in India, this article focuses on agri or agro commodity trading. Agri commodities are one of the four main commodity categories traded in India.
Here’s some imperative info one must have about agro commodity trading:
- What is it?
Agri commodity trading involves the buying and selling of agricultural produce like wheat, coffee, or palm oil in the commodity market.
- How does it work?
Retail traders perform agri commodity trading over an exchange like the Multi Commodity Exchange (MCX) by trading its futures contracts.
- Why is it important?
Trading agricultural products can help you hedge against volatile price meets in the commodity market that affect your other investments like stocks.
Too brief? Continue reading to learn in detail about each of the above points and more about agri commodity trading.
Table of Contents
Commodity Futures Market
When it comes to commodity trading, in general, you have two options:
- Trade the commodity in a physical market.
- Trade the commodity in the futures market over a regulated exchange.
As retail investors and traders, you’ll likely want to go with option two. Therefore, before making agri commodities the focal point of this piece, you need to know how commodity futures work. For that, it’s essential you first know what futures contracts entail in detail. A futures contract derives its value from an underlying security/asset and mandates the two parties (buyer and seller) to transact the underlying asset at a fixed price on a future date. You can trade a futures contract by only paying part of the total value of the contract; the remaining amount is paid when the underlying asset is delivered, which is the day the contract expires.
This was only the gist of how future contracts work, and it’s recommended that you learn about them in depth before making any trades.
How Commodity Futures Work
First, let’s address the elephant in the room: What will you do with the trading agri commodity futures? What will you do with several kilos of wheat or several liters of palm oil or any commodity, agro or not, for that matter?
Here’s where a special feature of commodity futures comes into play: cash settlement. The thing about commodity futures is that they do not involve the delivery of the actual commodity, at least on a retail investing scale.
Example: Assume you’re trading agricultural products like wheat in the futures market. If the price of wheat increases between now and when the wheat futures expire, you profit. On the other hand, if it goes down, you pay money. In no scenario will you get wheat.
- For simplicity’s sake, imagine you buy one lot of wheat futures tied to 10 kg of wheat.
- Now, suppose at that time, the futures price for a kilo of wheat was ₹100, so the total cost of the futures contract comes up to be ₹10,000 (1000×100).
- However, since it’s a futures contract—you only pay a part of the total contract value—so you can buy it by paying, let’s say, ₹4000.
- Now, when the contract expires, the price of what is ₹130. So, that means you’re bagging home a profit of ₹3000 (1300×10).
In summary, you get back the principal investment amount (₹4,000) and your profits of ₹3,000 by trading a futures contract worth ₹10,000.
Benefits of Agri Commodity Trading
All that said, you don’t primarily trade futures because you require only a portion of the entire amount to take a trading position or because you don’t actually get the commodity delivered to your home.
You do so to either hedge your investment portfolio against the price volatility in the agri commodity market or to speculate and profit off the price volatility of agri commodities. Let’s understand how exactly agri commodity trading can help you hedge your other investments through the following illustration.
Example: Assume you are a regular stock market investor, which means you are investing in businesses. Now, several businesses may use agricultural commodities to manufacture their products. For example, palm oil is an integral ingredient in many Fast Moving Consumer Goods (FMCG) businesses; it’s used in chocolates, chips, shampoos, etc. Likewise, cotton is the backbone of the textile industry.
- So, assume you’re an investor in an FMCG company that relies on palm oil to produce its primary product. Now, we’ll simplify things and understand how palm oil prices affect the company’s stock price.
- When the price of palm oil trades at ₹X, which is normal, the market is considered to be stable. It expects the company to record a profit margin of 15%. However, due to external factors, the price of palm oil shoots up significantly by ₹Y.
- Now, at ₹X+Y, there’s a panic in the market; investors of the FMCG stock now expect the company profit margins to fall significantly, say, to 10%. This may lead to a short-term or even longer downward curve in the corporate’s stock price.
- So, if you are an investor in that stock, you’ll lose money—or at least incur unrealised losses—on your investment in that FMCG company. However, you tracked the global palm oil market, and you foresaw a potential price rise in palm oil.
- By purchasing palm oil futures, you hedge your portfolio. Now, as the price of palm oil increases, your FMCG stock’s price may decline, but your long position in palm oil futures may turn out to be a lucrative compensation.
Three Factors That Influence Agricultural Commodity Prices
The two chief factors that affect agricultural commodity prices are—supply and demand. Now, this supply and demand in the agri commodity market may be affected by factors like:
- Weather conditions
- Geopolitical events
- Government policies
For instance, a nation’s government imposes an export ban on specific agri commodities grown in the country. Since the nation is a major exporter of a specific agri commodity, that will lead to a global shortage of that commodity. This will lead to the price of the commodity skyrocketing in commodity markets worldwide.
How Can You Trade Agri Commodities?
To start agri commodity trading in India, you must have a commodity trading account. Then, you can trade on commodity exchanges like the MCX and the NCDEX (National Commodity and Derivatives Exchange). Here are a few of the most frequently traded agri commodities:
- Coffee
- Cotton
- Sugar
- Crude Palm Oil
- Soybean
Conclusion
Agri commodity trading involves the buying and selling of agricultural products like wheat, coffee, cotton, etc. As a retail investor, you trade futures contracts of these agri commodities. You trade these commodities to hedge your investments or speculate. The price of these agri commodities is driven by demand and supply. Understand the workings of futures contracts before you start commodity trading.