For any investor, commodities can be a great way to extend and diversify their portfolio beyond traditional stocks and debentures. The prices of commodities tend to move in the opposite direction of traditional securities. This trait makes them a great hedge during periods of market volatility. Commodities are of two types: Soft commodities and hard commodities.
- Soft commodities: This category includes agricultural products like wheat, rice, sugar, corn, soybean, etc.
- Hard commodities: Hard commodities are usually mined and include minerals, metals, oil, gas, etc.
Now, commodity trading can be done for any of these commodities. But if you are a trader looking to generate high returns, then agro commodity trading may be the right choice. Agro commodity trading is facilitated via futures contracts.
A futures contract allows the trader to bet on the future price of a commodity at a fraction of a price without actually buying the commodity. Similarly, A futures contract in agro commodity trading is an agreement to sell or purchase a specified quantity of a particular agricultural commodity at predetermined prices on a future date. Agro commodity traded can also be initiated through Exchange Traded Funds (ETFs), and Exchange Traded Notes (ETNs).
Agro Commodity Trading: The History and Current Markets
India is predominantly an agricultural economy, which gives great scope to agricultural commodity trade. The Cotton Trade Association was set up in India back in 1875,, marking the beginning of agro commodity trading. Later on, futures trading was suspended in 1952 as there was a shortage of commodities for domestic consumption. The modern form of agro commodity trading began in 2002. In 2017, SEBI allowed trading in agricultural commodities via regular Demat account only.
Over 12% of the commodity trade is agro-based. Agro commodity trading doesn’t take place for all agricultural products. Traders can profit from speculating on the prices of agro commodities, typically cash crops such as pulses, cereals, oilseeds, rubber, fibers like cotton, jute, dry fruits, etc. Agri commodity trading occurs in all the major commodities in six commodity exchanges in India. These include:
- Multi Commodity Exchange of India Limited (MCX)
- National Commodity & Derivatives Exchange Limited (NCDEX)
- National Multi-Commodity Exchange (NMCE)
- Indian Commodity Exchange (ICEX)
- Ace Derivatives and Commodity Exchange Limited (ACEX)
- Universal Commodity Exchange (UCX)
Out of the six, the two major exchanges focused on agricultural commodities are National Commodity & Derivatives Exchange Limited (NCDEX) and National Multi-Commodity Exchange (NMCE).
The agro commodity trading markets are regulated by the Forward Market Commission (FMC), constituted in the early 1950s. FMC was later merged with SEBI in September 2015 to have a universal financial regulator looking over the market. Since then, SEBI has taken multiple initiatives to boost agro commodity trading in India via measures like:
- Introducing options trading in commodities,
- Allowing stockbrokers in commodity trading
- Allowing some categories of FIIs (Foreign Institutional Investors)
- Permitting NSE and BSE to introduce commodity trading on their respective trading platforms
Merits of Agro Commodity Trading `
Any trader who has a considerable understanding of how supply and demand forces work in the agricultural commodity markets can earn great returns on their capital. The returns on agro commodity trading are higher because the margins available on agro commodity trading are relatively higher than usual margins. The other benefits include:
- Under agro commodity trading, traders are provided with many options to trade from, which ensures diversification.
- Since the trading options are derivatives, agro trading options provide you with an effective hedge against market risks.
- Trading in agro commodities acts like an efficient price discovery mechanism allowing traders to estimate future prices.
How to Trade in Agro Commodities
Anyone who wants to start investing in agricultural commodities can begin by researching a commodity and speculating its price. Once you have shortlisted on the commodity you want to invest in and are confident of your future price assessment, you can go ahead and pay the margin amount to your broker and buy a futures contract of your chosen commodity. The sale will be executed at the date agreed upon in the futures contract.
Trading in agro commodities carries the same risk as stocks. If you are a trader interested in trading agro commodities, you should be aware of the market risk before placing bets in the market. Most of the information can be accessed online, and well-known strategies such as stop losses or options trading can be used to reduce risks. You should also be careful that brokers usually allow considerable leverage with regard to commodity trading. Hence, you should be aware of the risks and returns for the commodities you are trading in.
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