Advantages & Disadvantages of Commodity Trading

Online trading has become an increasingly popular way to manage investments and purchase assets without ever leaving the comfort of your own home.

In a world that is becoming more digital by the day, it makes sense why people are turning towards online trading options as they offer convenience, low fees, and access to a wide variety of markets. Markets such as commodities, which were not a new concept, also seem to dominate the online trade.

• Commodity trading refers to the buying and selling of raw materials, such as gold, wheat, or oil. This form of trading has been around for centuries, but with the advent of online platforms, it has become more accessible to everyday investors.
• The market comprises various asset classes such as metals, energy products, agricultural goods, and currencies.
• This diversification of investment in commodity trading provides opportunities for traders to hedge against inflation or economic turbulence by investing in different commodities simultaneously.
• In today’s times, traders have access to more sophisticated tools like futures contracts, options, and derivatives to trade in commodities.
• In India, the two largest trading exchanges for commodities are the Multi Commodity Exchange (MCX) and the National Commodity and Derivatives Exchange (NCDEX).  

With the right understanding of the market and its trends, you can use online trading to build your personal wealth more efficiently and diversify your investment by understanding the benefits of the commodity market and pros and cons of doing commodity trading.

Different Types of Raw Materials 

1. Agriculture Commodities: They include things such as corn, wheat, rice, soybeans, cotton sugar, coffee, and cocoa. These commodities are usually influenced by the weather, the world’s supply and demand, and government policies.
2. Metals: The commodities of metal that are traded in the market include copper, silver, gold, aluminium, nickel, zinc, and lead. These commodities are affected by factors such as economic conditions, geopolitical developments, and demand and supply dynamics.
3. Livestock: They include feed cattle, lean hogs, and pork bellies. These products are affected by climate, natural disasters, as well as supply and chain demand.
4. Industrial Raw Materials: These include wood, rubber, and many other items that are utilised in the manufacture of industrial goods. These materials are affected by world economic trends, demand and supply dynamics, and other geopolitical issues.
5. Energy Commodities: These include natural gas, crude oil, and various refined petroleum commodities. Energy commodities are influenced by factors such as demand and supply as well as geopolitical developments along with weather trends.

Advantages and Disadvantages of Commodity Trading 

Four major pros of commodity trading are as follows:

• In times of crisis, such as conflict, war, economic disruptions, or other devastating events, commodities can play a role in hedging your financial portfolio, as it becomes obvious to utilise the raw materials, which can also maintain stability on your commodity investment.
• Every nation on the planet faces an ultimatum known as inflation, but commodities play a major role in protecting from the rising inflation, as the demand for raw materials rises accordingly.
• You can also get the benefit of leveraging in the commodity trade, as the contract value you need to pay or add funds for is about 5% to 10% of the total value of the contract. You also need to maintain 23% of the total value of trade as your initial margin to maintain trading in the commodity market.
• Commodities have a negative or no correlation with stocks. Let’s take an example of oil prices increasing. This will have a negative correlation on stocks and decrease the price of companies that are using oil for their production. Therefore, commodities can be valuable assets to diversify your financial portfolio.

Disadvantages of Commodity Trading 

Two major cons of commodity trading is as follows:

• The concept of leverage is risky. If your trade goes sideways, then you can have a huge loss or impact your financial portfolio. Suppose you invest ₹10 in a lot size of 100. Then, you can end up losing up to ₹10,000 on your future trade.
• Suppose there is a slight change in the demand and supply; for example, the production of a commodity increases. In that case, this will decrease the price of the commodity, impacting the volatility in the market.
• Another drawback of commodity trading is that it is exposed to macroeconomics, where effects such as disaster or any other factor can harm the price of commodities.

As we discussed the pros and cons of commodity trading, now you will have a clear idea about whether to invest in the commodity instrument or not. Depending upon your financial goal, capital, and trading experience, you can enter the commodity trade.

Conclusion 

In a nutshell about the advantages and disadvantages of commodity trading:

• Commodity trading is a centuries-old practice of trading goods and services with the goal of making a profit.
• Traders seek out profitable opportunities within these markets, often leveraging the latest technology and market research to make informed decisions.
• Commodity trading is a complex and highly dynamic field in which many commodities can be difficult to map or predict due to several reasons.
• Before investing in commodity trading, it’s important to conduct thorough research on the specific commodity being considered. Factors such as historical price trends, current supply levels, and projected demand should all be analysed before making any investment decisions.

While commodity trading may not be suitable for all investors due to its inherent risks and volatility, it can offer potential benefits for those willing to thoroughly research the market and make informed decisions based on their individual financial situation.

Frequently Asked Questions (FAQs)