Commodity Trading : Overview, Advantages & Disadvantages

1. History of Commodity Trading

Commodity trading is not a new strategy and its origins dates back to ancient times, when people used to exchange a good for another one, and the process was known as barter system. With the progress of mankind and evolution of currencies, the barter system was phased out and commodities were bought and sold using currencies.

In the modern era, the exchange of commodities is still carried out throughout the world. Special commodity exchanges have been set up to look after the trade of commodities which functions similar to stock exchanges. Further, there are legal entities and governing bodies like Securities and Exchange Board of India who govern and look after the proper functioning of this whole system. Trading in commodities is done based on standardized commodity contracts and other related investment instruments.

2. Characteristics of Commodity Markets

Commodity market, similar to all other financial markets functions on the basic principle of Demand and Supply. Any alteration in the supply pattern will have an impact on demand and vice versa. If he demand is high and the supply is low, the prices will shoot and in case of low demand prices will drop drastically. Any disruption in the process of supply of commodities, like droughts and floods which can impact the supply of agriculture can lead to a sudden spike in the market.

The advancement in technology and economic development also impacts the commodity markets. For example, India has emerged as a significant production player, which indirectly means a requirement of higher volume of industrial metals. This will lead to a shortage in the supply of such industrial metals for the rest of the world.

3. Types of Commodities:

There are various types of commodity products available in the markets for trading and investing purposes which are broadly classified in to three main categories:

Metals: The category of metals include precious metals like gold and silver and non-precious metals like copper, lead etc. Investing in precious metals like gold is considered as a safe haven in the time of market volatility because of the high liquidity and comparatively stable nature. Investing in precious metals is also considered as a hedging instrument to beat inflation and currency devaluation. Commodity Bullion can help you by providing research based recommendations for trading in precious metals.

Energy: As the name suggests, this category includes sources of energy generation like crude oil, natural gas etc. Many new traders and investors are attracted to this category of commodities but they should be aware about the effect of economic downturns and shift in production patterns which have a direct impact on energy sector. Zeta Crude is a positional swing trading strategy which helps you capture the movements in crude oil. The advancement in technology which has boomed up the use of alternative sources of energy like wind energy, solar energy etc has also impacted the demand and supply pattern in this sector.

Agriculture: The commodities which are originated from agriculture are included in this category. Some of the examples of agriculture categories include soybean, cotton, maize etc. This category is affected mainly by climatic patterns and weather conditions. For example, any change in the rainfall pattern will affect the production, which will have a direct impact on the cost as per the demand and supply system.

4. Advantages of Commodity Trading

There are many advantages of commodity trading. Some of them are listed below:

• High Growth Opportunity: As you know that commodity markets work on the principle of demand and supply, any rapid increase in demand will have a direct impact on price. Thus, providing an opportunity to generate higher profits in a limited amount of time.
• Diversification: Diversification of your portfolio protects you against sudden lows and helps to keep your investment portfolio stable. Commodity market is the most preferred source of diversification from your investments in stocks and bonds by hedging. Investment in commodities as a hedge instrument helps you manage your risk in the markets.
• Security Against Inflation: Inflation can be very harmful for regular traders because during the inflation period, there can be a drop in your income from stocks and bond investments, but commodities are usually positive during inflation. The reason being, any increase in the prices of goods and services will lead to a surge in the demand of commodities required for production, thus increasing the costs.

These are some of the advantages of having commodities in your investment portfolio.

5. Disadvantages of Commodity Trading

There are certain disadvantages too associated with commodity trading, Let us discuss about them in detail:

• High Volatility: Commodities are rated as one of the highest volatile instruments amongst all other asset classes. As per a study, commodity market has twice the volatility of the stock market and four times the volatility of the bonds market. High volatility makes commodity market risky for some traders.
• High Risk: Trading in some of the commodities like crude oil requires a high risk bearing capacity. Commodity market comes with its own set of risks; therefore it is very important to have your risk profile evaluated before entering the world of commodity trading.

Commodity trading can be a great alternative to you investments in stocks and other instruments provided that you enter this market with proper research and knowledge because like all other financial markets, commodity market also has its own set of risks.