Understanding the basics of Futures trading in Agricultural Commodities

Neelesh has been trading for the last 5 years in stocks and has been successful in fulfilling some of his short-term financial objectives and targets. Now he wants to diversify his portfolio further for creating a retirement corpus. He had heard about Agricultural commodity trading, but was hesitant to invest. Based on his experience of learning stock trading he decided to try learning the concepts and basics of trading in the agricultural commodities trading.

He spoke to few of his friends employed in commodity broking firms, browsed various websites, kept on searching through various online sources like You tube etc. and could get a lot of insight in agricultural commodity trading. He was now clear of the fact that the tool available in agro commodities is mostly available in the form of futures, which can be used both for hedging and speculation. It was also clear to Neelesh that as an investor, it is necessary to research the market in order to make an inference regarding the price of a particular agro product. If the confidence regarding the to be bullish, is higher j and one should purchase a futures contract. For trading in commodity futures it is mandatory for paying the margin amount and start initiating the trades.  

Futures trading in commodity have the benefit of providing a substantial leverage, i.e. paying only a small amount compared with the total value of a commodity. There are number of instances where careful or disciplined trading has enabled long term traders, investors and small-time traders him to fulfill their investment objectives, over a period of time.  

Understanding Agricultural Commodities: 

An agricultural commodity is essentially a financial asset, in this case mostly a crop or a processed product of the crop, which can be exchanged or traded. In India, Agro commodities are mainly divided into the following categories: 

1. Oil complex (Castor/Soybean/Soymeal/Rape Mustard Seed/Crude Palm Oil and Soybean Oil). 

2. Spices (Jeera/Dhaniya and Turmeric)

3. Guar complex (Guarseedand Guargum)

4. Pulses (Mung and Chana). Cotton Complex (Kapas Cotton and Cotton Cake)

5. Grains ( Wheat/Maize/Bajra).

Out of these, the first four 4 commodity baskets currently attract the maximum trade attention. NCDEX and MCX are two national level commodity exchanges with most Agri commodities being traded actively at NCDEX. In MCX, commodities like Crude Palm Oil and Cotton are actively traded presently.  

Commodity trading in India: 

Trading in agro commodity can be traced back to 1875 in India, when the Cotton Trade Association was established in Bombay. But due to dearth of commodities for domestic consumption, futures trading in commodities were suspended in 1952. The Government then permitted trading in agro commodity futures 2002 onwards, as the markets started maturing and developing.  

Regulator for commodities trading: 

In the early 1950’s the Forward Market Commission (FMC) was constituted for providing a regulatory framework to the commodities trading market in India. It was later merged with the Securities Exchange Board of India (SEBI) in September 2015 to with the objective of establishing a universal financial regulator of the market. Subsequently, the SEBI enhanced the operational functionality of the commodity market through various   measures, such as introducing options trading in commodities, allowing stock brokers and few segments of Foreign Institutional Investors (FII) to deal/participate in commodity derivatives, permitting NSE and BSE to introduce commodity derivatives on their trading platforms and so on. 

Key Features of trading in agricultural commodities: 

Future and spot prices have a direct relationship, and hedging can help mitigate the risks associated with unexpected price fluctuations. Through futures trading the seasonal variations of prices are minimized, and farmers/producers benefit due to stable prices. In all commodity trading helps to stabilize  agricultural product prices by acting as a link between future and spot prices 

It becomes easy to develop efficient hedging and speculation strategies through commodities trading. For example if there is a significant future price variation, because of existing spot prices, an efficient hedging strategy can be worked out. On the other hand, if changes in future price impact existing spot prices, an efficient speculation strategy can be formulated. Thus, on the basis of current trends in the market, it allows for finding future prices. 

Trading in agricultural commodities enables retail and corporate investors to diversify their portfolios. The procedures of trading in commodities are nearly the same as trading in conventional stocks and securities. One needs to open a Demat Account and a Trading Account, and complete the requisite formalities. For making investments or trading in agro commodities, one should always consider the supply and demand-based factors along with seasonal and weather-related variables.  

Commodity exchanges have played an important role in creating an environment that enabled farmers and other market participants to grow their business with utmost confidence and trust. A well-developed commodities futures market is an advantage for farmers to predict their earnings and plan their future investments accordingly. Commodity futures trading serve an important function of for efficient price discovery and risk management.   

Stay tuned for more coverage/insights on the concepts/key aspects of Agri commodities futures trading: keep browsing the Agripedia/Agriculture World and the Commodities sections