Points To Remember Before Trading In Commodities Market

14.1. Diversify

You must be humble enough to accept that despite numerous forecasts, extensive analysis, and technical research, mistakes are bound to happen. However, a successful trader is not the one who never makes losses, but someone who anticipates such losses and accordingly diversifies his portfolio in different commodities, such that losses suffered in one set of commodities is offset by the gains attained in another set of commodities. Also, the factors that determine the price of one commodity may be very different from those that determine the price of another commodity. E.g., an economy in decline may lessen the production activity, due to reduced demand for discretionary items such as cars. This will invariably reduce the demand for crude oil, hence slashing their prices. However, the prices of wheat may be unaffected as these are essential commodities required for subsistence. Therefore, it is vital not to pin all your hopes on one set of commodities to help generate wealth in the commodities markets

14.2. Understand the cyclical nature of the commodities market

Usually, all commodities move in cyclical trends which are determined by the interplay of demand and supply and economic and geopolitical factors. As a successful investor, you must spot the stage in the cycle; the commodities market is currently at to benefit from the price swings in the market. Also, as a trader, you play a crucial role in driving the cycle and bringing about the supply and demand equilibrium.

There is an increase in demand

• Capital expenditure is increased to increase the production to meet the growing demand
• This pushes the prices up due to high capital expenditure, and also due to demand outweighing the supply.
• However, higher prices start dampening and eroding the demand
• The supply slowly exceeds the demand leading to a fall in commodity prices to increase the demand.
• Capital expenditure is reduced to accommodate the reduction in prices, which reduces the supply and subsequently bringing about a supply and demand equilibrium
• And then the process starts all over again

14.3. Select an appropriate exchange

You must select an exchange where there is ample liquidity, so commodity futures can be freely bought or sold, without the constant worry of finding a buyer or a seller. Also, the clearinghouse of the exchange acts as a counterparty to both the parties involved in the trade. This eliminates any credit risk. Also, the risk is reduced further as all the leading exchanges require the positions in commodity futures to be marked to market on a daily basis. Hence, any counterparty risk is eliminated on selecting an appropriate exchange. Also, you must select an exchange based on their track record in commodities. E.g., MCX is renowned and strong for non-agri commodities, while NCDEX is stronger in agri commodities. A learner in the commodities market must be well-acquainted about the facts and mechanics of the leading commodity exchanges.

14.4. Manage Volatility

Volatility is a word you will continuously hear and associate with while trading in commodities. Volatility is the degree of variation in the prices of the commodities i.e. the rate at which the prices increase or decrease. The volatility in commodities is unmatched and uncompromising. It is like a tornado that can swipe away all your profits, but on the other hand, if adequately cashed in can offer huge gains. So, in commodity trading, you must understand that commodities have different volatilities. You must establish the price range of each commodity and trade accordingly. You must determine the lot sizes based on the extent of the volatility and not based on margin requirements.

Volatility will determine the risk/return profile of commodities as highly volatile products generate high returns at the same time; there is increased risk due to the unpredictability and higher degree of fluctuation in the prices of the commodities. A beginner trader should take more significant positions in commodities with low volatility like gold, oil, and lower positions in commodities with high volatility like copper, and agricultural products. These are some of the tips in commodity trading that a beginner trader should follow to garner profits. It is advisable to restrict trading to a few commodities, and once you become a seasoned trader, you can expand your portfolio to include more commodities.