Commodity Trading
Commodity Trading
Commodity Trading
Trade is also
called commerce or transaction. A mechanism that allows trade is called a market. The original
form of trade was barter, the direct exchange of goods and services. Later one side of the barter
were the metals, precious metals (poles, coins), bill, paper money. Modern traders instead
generally negotiate through a medium of exchange, such as money. As a result, buying can be
separated from selling, or earning. The invention of money (and later credit, paper money and
non-physical money) greatly simplified and promoted trade. Trade between two traders is called
bilateral trade, while trade between more than two traders is called multilateral trade.
Trade exists for man due to specialization and division of labor, most people concentrate on a
small aspect of production, trading for other products. Trade exists between regions because
different regions have a comparative advantage in the production of some tradable commodity, or
because different regions' size allows for the benefits of mass production. As such, trade
at market pricesbetween locations benefits both locations.
Retail trade consists of the sale of goods or merchandise from a very fixed location, such as
a department store, boutique or kiosk, or by mail, in small or individual lots for
direct consumption by the purchaser.[1] Wholesale trade is defined as the sale of goods
ormerchandise to retailers, to industrial, commercial, institutional, or other
professional business users, or to other wholesalers and related subordinated services.[2]
Trading can also refer to the action performed by traders and other market agents in the financial
markets.
Development of money
Main article: History of money
The first instances of money were objects with intrinsic value. This is called commodity
money and includes any commonly available commodity that has intrinsic value; historical
examples include pigs, rare seashells, whale's teeth, and (often) cattle. In medieval Iraq, bread
was used as an early form of money. In Mexico under Montezuma[disambiguation needed]cocoa beans
were money. [1]
Roman denarius
Currency was introduced as a standardised money to facilitate a wider exchange of goods and
services. This first stage of currency, where metals were used to represent stored value, and
symbols to represent commodities, formed the basis of trade in the Fertile Crescent for over 1500
years.
Numismatists have examples of coins from the earliest large-scale societies, although these were
initially unmarked lumps of precious metal.[5]
Ancient Sparta minted coins from iron to discourage its citizens from engaging in foreign trade.
The stock market also provides opportunities for short-term investors. Market
skittishness can cause prices to fluctuate quite rapidly and investor psychology can
cause prices to fall or rise – even if there is no financial basis for these variations.
How does this happen? News reports, government announcements about the
economy, and even rumours can cause investors to become nervous or to suspect
that a company will increase in value. When the price starts to fall or rise, other
investors will jump on the bandwagon, causing an even faster acceleration in price.
Eventually the market will correct itself, but for savvy short-term investors who
watch the market closely, these price changes can offer opportunities for profitable
trading.
Short term traders are divided into 3 categories: Position Traders, Swing Traders,
and Day Traders.
Position Traders
Position trading is the longest term trading style of the three. Stocks could be held
for a relatively long period of time compared with the other trading styles. Position
traders expect to hold on to their stocks for anywhere from 5 days to 3 or 6 months.
Position traders are watching for fundamental changes in value of a stock. This
information can be gleaned from financial reports and industry analyses. Position
trading does not require a great deal of time. An examination of daily reports is
enough to plan trading strategies. This type of trading is ideal for those who invest in
the stock market to supplement their income. The time needed to study the stock
market can be as little as 30 minutes a day and can be done after regular work
hours.
Swing Traders
Swing traders hold stocks for shorter periods than position traders – generally from
one to five days. The swing trader is looking for changes in the market that are
driven more by emotion than fundamental value. This type of trading requires more
time than position trading but the payback is often greater. Swing traders usually
spend about 2 hours a day researching stocks and executing orders. They need to be
able to identify trends and pick out trading opportunities. They usually rely on daily
and intraday charts to plot stock movements.
Day Traders
Day trading is commonly thought of as the most risky way to play the stock market.
This may be true if the trader is uneducated, but those who know what they are
doing know how to limit their risk and maximize their profit potential. Day trading
refers to buying and selling stock in very short periods of time – less than a day but
often as short as a few minutes. Day traders rely on information that can influence
price moves and have to plot when to get in and out of a position. Day traders need
to be rational and analytical. Emotional buyers will quickly lose money in this type of
trading. Because of the close attention needed to market conditions, day trading is a
full-time profession.
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Commodity markets are markets where raw or primary products are exchanged. These raw
commodities are traded on regulated commodities exchanges, in which they are bought and sold
in standardized contracts.
This article focuses on the history and current debates regarding global commodity markets. It
covers physical product (food, metals, electricity) markets but not the ways that services,
including those of governments, nor investment, nor debt, can be seen as a commodity. Articles
on reinsurance markets,stock markets, bond markets and currency markets cover those concerns
separately and in more depth. One focus of this article is the relationship between
simple commodity money and the more complex instruments offered in the commodity markets.
History
The modern commodity markets have their roots in the trading of agricultural products. While
wheat and corn, cattle and pigs, were widely traded using standard instruments in the 19th
century in the United States, other basic foodstuffs such as soybeans were only added quite
recently in most markets.[citation needed] For a commodity market to be established, there must be very
broad consensus on the variations in the product that make it acceptable for one purpose or
another.
The economic impact of the development of commodity markets is hard to overestimate. Through
the 19th century "the exchanges became effective spokesmen for, and innovators of,
improvements in transportation, warehousing, and financing, which paved the way to expanded
interstate and international trade."[citation needed]
Commodity money and commodity markets in a crude early form are believed to have originated
in Sumer where small baked clay tokens in the shape of sheep or goats were used in trade.
Sealed in clay vessels with a certain number of such tokens, with that number written on the
outside, they represented a promise to deliver that number. This made them a form of commodity
money - more than an I.O.U. but less than a guarantee by a nation-state or bank. However, they
were also known to contain promises of time and date of delivery - this made them like a
modern futures contract. Regardless of the details, it was only possible to verify the number of
tokens inside by shaking the vessel or by breaking it, at which point the number or terms written
on the outside became subject to doubt. Eventually the tokens disappeared, but the contracts
remained on flat tablets. This represented the first system of commodityaccounting.
However, the commodity status of living things is always subject to doubt - it was hard to validate
the health or existence of sheep or goats. Excuses for non-delivery were not unknown, and there
are recovered Sumerian letters[citation needed] that complain of sickly goats, sheep that had already
been fleeced, etc.
If a seller's reputation was good, individual backers or bankers could decide to take the risk
of clearing a trade. The observation that trust is always required between market participants later
led to credit money. But until relatively modern times, communication and credit were primitive.
Classical civilizations built complex global markets trading gold or silver for spices, cloth, wood
and weapons, most of which had standards of quality and timeliness. Considering the many
hazards of climate, piracy, theft and abuse of military fiat by rulers of kingdoms along the trade
routes, it was a major focus of these civilizations to keep markets open and trading in these
scarce commodities. Reputation and clearing became central concerns, and the states which
could handle them most effectively became very powerful empires, trusted by many peoples to
manage and mediate trade and commerce.
The notional value outstanding of banks’ OTC commodities’ derivatives contracts increased 27%
in 2007 to $9.0 trillion. OTC trading accounts for the majority of trading in gold and silver. Overall,
precious metals accounted for 8% of OTC commodities derivatives trading in 2007, down from
their 55% share a decade earlier as trading in energy derivatives rose.
Global physical and derivative trading of commodities on exchanges increased more than a third
in 2007 to reach 1,684 million contracts. Agricultural contracts trading grew by 32% in 2007,
energy 29% and industrial metals by 30%. Precious metals trading grew by 3%, with higher
volume in New York being partially offset by declining volume in Tokyo. Over 40% of commodities
trading on exchanges was conducted on US exchanges and a quarter in China. Trading on
exchanges in China and India has gained in importance in recent years due to their emergence
as significant commodities consumers and producers. [1]
Returns
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Studies show that fully-collateralized commodity futures have historically offered the same return
and Sharpe ratio as equities[3]. Commodities have an approximate expected return of 5% in real
terms which is based on the risk premium for 116 different commodities weighted equally since
1888 (Source Report 219171-Wharton Business School). Investment professionals often too
mistakenly claim there is no risk premium in commodites.[citation needed]
[edit]Spot trading
Spot trading is any transaction where delivery either takes place immediately, or with a minimum
lag between the trade and delivery due to technical constraints. Spot trading normally involves
visual inspection of the commodity or a sample of the commodity, and is carried out in markets
such as wholesale markets. Commodity markets, on the other hand, require the existence of
agreed standards so that trades can be made without visual inspection.
Futures contracts
A futures contract has the same general features as a forward contract but is transacted through
a futures exchange.
Commodity and futures contracts are based on what’s termed forward contracts. Early on these
forward contracts — agreements to buy now, pay and deliver later — were used as a way of
getting products from producer to the consumer. These typically were only for food and
agricultural products. Forward contracts have evolved and have been standardized into what we
know today as futures contracts. Although more complex today, early forward contracts for
example, were used for rice in seventeenth century Japan. Modern forward, or futures
agreements, began in Chicago in the 1840s, with the appearance of the railroads. Chicago, being
centrally located, emerged as the hub between Midwestern farmers and producers and the east
coast consumer population centers.
[edit]Hedging
Whole developing nations may be especially vulnerable, and even their currency tends to be tied
to the price of those particular commodity items until it manages to be a fully developed nation.
For example, one could see the nominally fiat money of Cuba as being tied to sugar prices[citation
needed]
, since a lack of hard currency paying for sugar means less foreign goods per peso in Cuba
itself. In effect, Cuba needs a hedge against a drop in sugar prices, if it wishes to maintain a
stable quality of life for its citizens.[citation needed]
[edit]Standardization
U.S. soybean futures, for example, are of standard grade if they are "GMO or a mixture of GMO
and Non-GMO No. 2 yellow soybeans of Indiana, Ohio and Michigan origin produced in the
U.S.A. (Non-screened, stored in silo)," and of deliverable grade if they are "GMO or a mixture of
GMO and Non-GMO No. 2 yellow soybeans of Iowa, Illinois and Wisconsin origin produced in the
U.S.A. (Non-screened, stored in silo)." Note the distinction between states, and the need to
clearly mention their status as GMO (Genetically Modified Organism) which makes them
unacceptable to most organic food buyers.
Similar specifications apply for cotton, orange juice, cocoa, sugar, wheat, corn, barley, pork
bellies, milk, feedstuffs, fruits, vegetables, other grains, other beans, hay, other livestock, meats,
poultry, eggs, or any other commodity which is so traded.
Generally, commodities' spot and forward prices are solely dependent on the financial return of
the instrument, and do not factor into the price any societal costs, e.g. smog, pollution, water
contamination, etc. Nonetheless, new markets and instruments have been created in order to
address the external costs of using these commodities such as man-made global warming,
deforestation, and general pollution. For instance, many utilities now trade regularly on the
emissions markets, buying and selling renewable emissions credits and emissions allowances in
order to offset the output of their generation facilities. While many have criticized this as a band-
aid solution, others point out that the utility industry is the first to publicly address it's external
costs. Many industries, including the tech industry and auto industry, have done nothing of the
sort.
In the United States, the principal regulator of commodity and futures markets is the Commodity
Futures Trading Commission.
Since the detailed concerns of industrial and consumer markets vary widely, so do the contracts,
and "grades" tend to vary significantly from country to country. A proliferation of contract units,
terms, and futures contracts have evolved, combined into an extremely sophisticated range
of financial instruments.
These are more than one-to-one representations of units of a given type of commodity, and
represent more than simple futures contracts for future deliveries. These serve a variety of
purposes from simple gambling to price insurance.
[edit]Oil
Building on the infrastructure and credit and settlement networks established for food
and precious metals, many such markets have proliferated drastically in the late 20th century. Oil
was the first form of energy so widely traded, and the fluctuations in the oil markets are of
particular political interest.
Some commodity market speculation is directly related to the stability of certain states, e.g. during
the Persian Gulf War, speculation on the survival of the regime of Saddam Hussein inIraq. Similar
political stability concerns have from time to time driven the price of oil.
The oil market is an exception. Most markets are not so tied to the politics of volatile regions -
even natural gas tends to be more stable, as it is not traded across oceans by tanker as
extensively.
There are signs, however, that this regime is far from perfect. U.S. trade sanctions against
Canadian softwood lumber (within NAFTA) and foreign steel (except for NAFTA partners Canada
and Mexico) in 2002 signalled a shift in policy towards a tougher regime perhaps more driven by
political concerns - jobs, industrial policy, even sustainable forestry and logging practices.
Commodity trading
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worldwide trading volumes in commodities are 4-5 times that of trading in shares and stocks?
While most of us are familiar with investing in stocks and shares, commodities as a worldwide accepted
asset class, can be an interesting way to have your money make money for you.
Just as trading in shares and stocks, the equity market, is regulated by Securities and Exchange Board of
India (SEBI), trading in commodity futures and the relevant exchanges viz. MCX (Multi Commodity
Exchange of India Ltd.), NCDEX (National Commodity & Derivatives Exchange Ltd.), NMCE (National Multi-
Commodity Exchange of India Limited), etc. are regulated by the Forward Markets Commission (FMC).
• Lowest Margins – Equity Futures usually have 10-25% margins, but commodities
typically require 5-15% margins. For E.g. one lot of 100gm gold would have an approximate
margin of Rs. 6000 only, against the cost of the actual quantity.
• Extended Trading Hours – Although trading hours for Equity Market is from 10:00am-
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11.30pm. So you can go trade even after your office hours.