Benefits of Commodity Trading

Commodity trading online has emerged as a viable alternative to capital market investments. Commodities, unlike stocks, are sold through spot, futures, and options contracts. Commodity prices are influenced by various factors such as geopolitical events, government policies, demand or supply limits, production conditions, and so on.

Reduced volatility, insurance against inflation or geopolitical crisis, diversity, and other benefits are among the benefits of commodity market investments.

Investors in the twenty-first century are better informed. They understand the numerous benefits of diversity. If you’re unfamiliar with the term “diversity,” let me explain it in a single sentence: Diversification is spreading your wealth across multiple financial instruments to spread your risks and maximize your profits.

Inflation is a terrible word for people who buy physical goods. Conversely, inflation may be your best friend if you trade commodities online. Inflation is simply an increase in commodity prices. As a result, if you own a commodity whose price is rising, your portfolio’s value will also rise. This ensures that your purchasing power remains constant even if inflation reaches its highest level in history. Stocks and bonds typically fall when inflation rises because inflation frequently dries up liquidity and reduces purchasing power.

Online commodity investments outperform real estate and fixed deposits because they are completely liquid and can be sold anytime. Commodities, like stocks, are simple to buy and sell. As a result, commodity derivatives can be a safe bet if you want more control over your finances.

Should You Invest in Commodities?

Commodity trading is generally regarded as more reliable than equity stock trading. However, investors familiar with stocks and sectors see equities as more profitable and easier to understand than commodities. Online commodity trading may open up new doors for you.

As a result, your decision to invest in a commodity should be based on your risk tolerance rather than your emotions. 5paisa is the broker of choice for those looking for low-cost brokerage and accurate order execution.

Detailed Benefits of Commodity Trading

There are numerous advantages to trading in commodities.

Inflationary safeguards

As demand for goods and services grows, the cost of raw materials, or commodities, rises, causing the price of goods and services to rise.

In an inflationary environment, interest rates rise, raising the cost of borrowing and reducing the company’s net profitability. A decrease in revenue affects the profits distributed to shareholders. Equities’ prices fall as a result of inflation. In contrast, rising demand raises the prices of commodities used to produce finished goods, resulting in a price increase for the final products. As a result, investors flock to commodities futures to protect their capital from inflation and preserve its value.

Structure with a high leverage

Commodity derivatives, such as futures and options, provide much leverage. You can gain control of a significant position by paying only 5 to 10% of the contract’s value as a margin upfront. Any change in commodity prices could result in exponential benefits. Using leverage in commodity trading opens up the possibility of huge gains.

The minimum margin required for commodities futures varies but is significantly lower than needed for trading stocks. For wheat futures, for example, only 23% of the total trading value is necessary as the first margin.

Diversification

Commodities and stocks have a negative or low correlation. Commodities are typically the raw materials needed to create the final product.

Increasing commodity prices raise production costs, reducing profits and leaving little for shareholders, resulting in lower earnings per share. This eventually leads to a drop in stock prices. As a result, when inflation is stable or declining, equities perform well. On the other hand, commodity performance improves as the inflation rate rises.

For example, as oil prices rise, so does the cost of owning a car, resulting in a drop in car sales. As a result, the value of auto stocks falls. Similarly, as metal prices rise, so does the cost of building houses, limiting demand for real estate and reflecting falling stock prices. As a result of this negative correlation, when commodity prices rise and stock prices fall, gains in commodity derivatives may offset stock losses. Thus, the addition of commodities diversifies a portfolio.

Commodity supply and demand are influenced by fundamental factors such as weather, strikes, and geopolitical instability. However, equities and bonds do not respond similarly to fundamental factors. As a result, the movement of commodity prices is unrelated to the direction of stock prices. Commodities are an attractive investment for portfolio diversification due to their negative or low correlation with equities.

Transparency

In contrast to the previous outcry approach, commodity transactions are now handled on an electronic trading platform accessible to all market participants.

The electronic trading platform facilitates the discovery of fair prices without needing buyer-seller interaction. The price is determined by supply and demand, so there is no room for manipulation. When the price and quantity quoted by the vendor and customer are the same, the price is discovered. The buyer and seller remain anonymous throughout the transaction, allowing for transparent price discovery with no room for manipulation.

Disadvantages of Commodity trading

Leverage

Leverage can be a double-edged sword at times. As previously discussed, leverage allows you to control a significant position with little initial capital.

Volatility

Commodity prices are highly volatile and highly dependent on demand and supply factors. The commodity price elasticity of supply and demand is zero.

Price inelasticity means that as the price of an item rises or falls, the supply remains constant. For example, increasing commodity output by cultivating new crops, extracting natural gas from the earth, and extracting iron from iron ore deposits all take a long time.

Furthermore, because goods are necessities of daily life, price changes will not affect demand because customers are accustomed to them, preventing them from seeking alternatives. Switching from gasoline or diesel-powered automobiles to electric or fuel-efficient vehicles is neither profitable nor practical in the medium term. Transitioning from nonrenewable energy sources, such as coal-fired electricity, to renewable energy sources, such as solar power takes time. A small change in market fundamentals can result in significant price fluctuations due to the cumulative inelastic demand and inelastic supply.

This sluggish response to supply and demand implies that supply and demand shocks, such as natural disasters or uneven precipitation, can significantly impact commodity prices. As a result, financial products based on these commodities are highly volatile.

Diversity is not encouraged.

The consensus is that the relationship between commodity prices and stock prices is negative or weak. As previously stated, when stock prices fall, commodity prices should skyrocket. Unemployment and decreased demand prevented significant output, resulting in a decrease in energy consumption. Furthermore, credit facility tightening resulted in a lack of cash or financial resources to make purchases, resulting in lower corporate profitability and layoffs, and an increase in unemployment, which exacerbated the demand contraction and pushed down oil and gas prices.

Concentration of assets

While diversification is one reason for including commodities in a portfolio, commodity funds are concentrated in one or two industries and thus undiversified. As a result, commodity price changes can significantly impact the share price of a commodity exchange-traded fund.

Frequently Asked Questions:

How much funds do I require to start trading commodities?

When trading futures, you must choose your initial capital, which should include more than just the legal minimums. The amount of money required to trade various futures contracts varies significantly. Furthermore, the risk of initiating a losing position is exceptionally high. Suppose a trader suffers a significant positional loss. In that case, the broker will close the trade, locking in the losses and potentially wiping out the trader’s entire or a substantial portion of their account value. A beginner trader should include a buffer of extra funds when deciding how much money to use to begin trading futures.

Commodity Futures Trading Commission-registered dealers trade futures (CTFC). Each broker sets its account opening deposit requirements. The minimum initial balance for a futures broker account is approximately $2,500. Most commodity futures brokers require a $5,000 to $10,000 deposit for new accounts. A new trader should compare various brokers’ requirements, fees, and services.

Is commodity trading profitable?

Commodities are used in almost every aspect of society. The demand for and supply of goods, as well as their prices, are constantly changing. Essential commodities, unlike fictitious components, have genuine utility and market value. They are taken in and enrich our lives. You can trade commodities with reasonable risk-adjusted returns if you understand the demand and supply dynamics that influence commodity prices.

What are the top ten commodities?

The ten most significant sources of cash from the sale of U.S.-produced farm commodities were (in descending order) cattle/calves, corn, soybeans, dairy products/milk, miscellaneous crops, broilers, hogs, wheat, chicken eggs, and hay, according to the USDA’s Economic Research Service’s Farm Income and Wealth Statistics.

Is commodity trading risky?

Stocks are not a perfect match if you are looking for an investment that precisely matches the price of a commodity. Even if the value of the commodity falls, a well-managed business can still generate profits. This, however, works both ways. While rising oil prices may benefit the stock price of an oil company, other factors such as corporate management and market share also play a role.