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Commodity and Currency Trading Explained

In this episode of Dhan ki Baat, Chintan Modi, Executive Vice President, IIFL, explains the process of Commodity and Currency trading.

1187 views  5 Feb 2018

Understanding Commodity and Currency Trading

Commodity trading:

Commodities, whether they are related to energy, metals or agri, are an essential part of everyday life. They also form an important component of running a business. For instance, a hotelier would be affected by a decline or rise in agri prices.

Commodities are also used to diversify a portfolio against market risk. In volatile or bearish stock markets, investors transfer money to precious metals such as gold and silver that have been historically viewed as precious metals. Commodities can also be used as a hedge against high inflation or during periods of currency devaluation.

Today, tradeable commodities fall into four categories. These are:

  • Bullions (gold and silver)
  • Metals (copper, lead, zinc, nickel, aluminium)
  • Energy (crude oil, heating oil, natural gas and gasoline)
  • Agricultural (guarseed, soybeans, jeera, cotton and sugar)

Commodity market:

Derivatives such as Future & Option are traded on the commodities exchange. Future contract is an agreement between the buyer and the seller to buy or sell a particular asset of specific quantity and at a predetermined price at a specific date in future.

The underlying asset in a future contract could be a commodity, stocks, currencies, or bonds. It helps to transfer the prices risk from hedgers to speculators.

Benefits of trading in commodity market:

Commodities market is mainly driven by demand and supply. It is easy to understand and easy to trade. Margin requirements to trade the future contract is very low i.e. 5-8%. Trading hours are longer in commodity market; it starts from 10 am and is open till 11.30 pm, and extended till 11.50 pm, in accordance with the daylight saving timings schedule.

Further, trading in the commodity market is beneficial as it is difficult to manipulate prices in a commodities contract as it is derived from global markets.

Commodity exchanges in India:

Multi-Commodity Exchange of India Limited (MCX), National Multi-Commodity & Derivatives Exchange of India Limited (NCDEX)

Currency trading:

Currency trading is defined as the buying and selling of international currencies. In general,banks and financial trading institutions are engaged in currency trading. However, individual investors can also participate and make capital gains from variations in the exchange rate of the currencies.

Currencies are frequently traded in the forex market globally are as follows:

Euro/US dollars (EUR/USD)
US dollar/Japanese yen (USD/JPY)
British pound/dollar (GBP/USD)
US dollar/Swiss franc (USD/CHF)
Australian doller/US dollar (AUD/USD)
US dollar/Canadian dollar (USD/CAD)

Benefits of currency trading:

Portfolio diversification
Hedging (specially for importers/exporters)
Low margin-high leverage
Limited scripts to track
Serves as a separate asset class for market savvy investors, arbitrageurs and speculators
Far from manipulation

Currency derivatives:

In terms of market share, currency market is internationally very mature and bigger than equity and commodity markets. Currency derivatives are a contract between the seller and buyer, whose value is to be derived from the underlying asset i.e. the currency value. A derivative based on currency exchange rate is an agreement that two currencies can be exchanged in a specific quantity of a particular currency pair at a future date.

Indian currency markets have noticed heightened activities and extreme volatilities in last couple of years. The developments taking place in the Indian forex market have brightened the prospects for investors and traders.

Currency derivatives can be Future and Options contracts, which are similar to the stock Futures and Options, but the underlying asset happens to be a currency pair (i.e. USDINR, EURINR, JPYINR OR GBPINR) instead of stocks. Currency derivatives are available on four currency pairs viz. US Dollars (USD), Euro (EUR), Great Britain Pound (GBP) and Japanese Yen (JPY). Currency options are currently available on US Dollars.

Participants in commodity and currency market:

Hedgers: They try to reduce the risk associated with uncertainty. Hedgers involve taking an offsetting position in a derivative in order to balance any gains and losses to the underlying assets.
Speculators: They are typically seen as risk takers and they love volatility. They bet against or with the movements of the market to try make profit from the fluctuation in the price of the underlying assets.

Factors affecting different commodities and currency trading:

There are a number of factors that affects commodities and currency trading. Besides geopolitical issues, factors such as US economic data ((nonfarm payroll data), Federal Reserve interest rate, GDP data, new home sales/pending home sales, crude oil/Natural gas inventories data and oil rig count data impact commodities and the currency market. Chinese economic data such as GDP, export and import also affects the market.