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How to Open a Commodity Trading Account

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The commodity markets are global markets where traders buy and sell various commodities. These may be physical substances that are grown, mined, or extracted, rather than manufactured products and services.

Furthermore, the commodity markets mainly deal in derivatives instruments like futures and options. Traders generally place trading orders that are due to be executed at a future pre-decided date. The prices of these instruments are readily available on the commodity exchange. Much like stock prices, they fluctuate based on the demand and supply of commodities worldwide. Find out why stock prices move up and down.

What commodities are traded on the commodity exchanges? They can be divided into four main categories: agricultural, metals, precious metals, and energy.

Agricultural

Agricultural commodities include:

  • Cotton
  • Soya bean
  • Chana
  • Tur dal
  • Black pepper
  • Cardamom
  • Castor seed
  • Crude palm oil
  • Kapas
  • Mentha oil
  • Palmolein
  • Guar seed and gum
  • Refined oil
  • Sugar
  • Turmeric
  • Wheat
  • Maize
  • Moong
  • Rice

Metals

These include commodities like:

  • Aluminium
  • Brass
  • Copper
  • Lead
  • Nickel
  • Zinc

Precious Metals

These include:

  • Gold
  • Silver
  • Platinum

Energy

This includes commodities such as:

  • Crude oil
  • Natural gas

How commodity trading works

Commodity traders buy and sell these commodities mainly via futures and options contracts on commodity exchanges. Among the leading commodity exchanges in India are Multi Commodity Exchange (MCX), National Commodity Derivative Exchange (NCDEX), and Indian Commodity Exchange (ICE). MCX and NCDEX handle the bulk of the trades in the country.

Before you start trading on these exchanges, it is important to have a clear picture of how futures and options contracts work:

  • Futures give you the right to purchase or sell a product at a fixed price on a fixed date in the future.
  • Options give you the right but not the obligation to buy or sell the product at a fixed price on a specified date in the future.

Let’s consider this with the help of an example: Say, you hold a gold option. You could choose not to buy or sell the gold. But if you have a futures contract, you will need to hold up your end of the bargain—that is, you will have to buy or sell the gold on the specified date. Learn more about futures contracts and options trading, and find out how they differ.

Does this mean every trader actually purchases the commodity based on the expected future price? No. Let’s explain this:

A trader who takes a buy (or sell) position can exit that trade by taking an opposite position. Say, you buy a crude oil future which states you will purchase one lot at Rs 963 for delivery in one month. You can exit the trade by selling crude oil at any price above Rs 963 and thus close your trade. Your action of buying one lot of crude oil is cancelled by your action of selling one lot of crude oil. The difference in the price is your gain or loss on the transaction.

Learn more about online commodity trading. Also, find out about the difference between intraday and delivery trading.

Commodity trading: Points to remember

  • Availability of commodities on the exchange
  • The commodities traded on each exchange are slightly different. Each exchange has a list of commodities that can be traded through their platform. Factor this in and think about the commodities you want to trade in. This will help you to zero in on a suitable exchange. You can then open a commodity trading account with a broker that is registered with that particular exchange.

  • Trading account requirements
  • Many people wonder if they can place commodity trades through their existing trading account. Now, a regular trading account opened with a stockbroker allows you to trade in stocks, mutual fund units, exchange-traded funds, and derivatives linked to stocks and stock indices. But stockbrokers are not authorised to conduct trades in commodities. There are separate commodity brokers who have permission to conduct trades in the commodity markets. Commodity brokers have to be registered with either MCX or NCDEX as well as the Securities and Exchange Board of India (SEBI).

  • Importance of squaring off positions
  • Unlike the stock markets, the commodity markets deal in physical commodities. Say, you buy chana futures for delivery in three months. If you don’t square off your contract, the seller will have to buy chana from the spot market and give you delivery. The commodity markets also remain open 24 hours a day, and commodity prices are constantly changing. This may be a challenge for beginners. But seasoned traders know how to place multiple trades throughout the day based on the constant price fluctuations.

  • Role of margin account
  • When you purchase equity shares or mutual funds outright in the spot market, you need to deposit cash equal to the purchase price plus brokerage. But the derivatives market does not require the entire cash up front. You can take positions of up to a certain multiple of your margin balance. This essentially means that you borrow funds from the broker. It is called leverage trading. Say, you purchase 200 lots of crude oil futures at Rs 963. Here, your total cost is Rs 1,92,600. But the broker may ask you to maintain a balance of just Rs 20,000 (10% of the total value) in your margin account.

    Know the difference between spot and futures pricing.

Open commodity trading account in a few steps

Getting a commodity trading account with a reputed broker should be your first step as a commodity trader. You can open this account both online and offline.

Documents required to open commodity trading account

  • Fill out the application form.
  • Submit standard Know-Your-Customer (KYC) documents. These are needed for account verification.
    1. a. Proof of identity: passport, voter’s ID, driving license, PAN card, Aadhaar card
    2. b. Proof of address: passport, voter’s ID, driving license, Aadhaar card, electricity bill, telephone bill, gas bill, home rental agreement, home loan agreement, property ownership agreement etc.
  • A member–client agreement will need to be executed between you and the commodity broker. Here’s what you need to know:
    • a. The agreement is prepared on non-judicial paper.
    • b. It outlines the terms of service as well as the role and responsibilities of the broker. Some brokers also mention their various fees and charges in the agreement. Review the agreement carefully to know the services available to you and the costs you might incur.
    • c. The agreement must be executed. This means it has to be stamped by a competent legal authority. A revenue stamp will be affixed to the agreement to signify its validity. You will also need to pay stamp duty and registration fees depending on the applicable state government rules.
  • Submit the required income proofs. These may include:
    • a. Statements of your business accounts
    • b. A copy of your ITR V or Form 16
    • c. Bank statement for the previous six months
    • d. Net worth certificate
    • e. Certificate of demat holdings
  • Submit details of your demat account. The commodity trading account has to be linked to the demat account. This allows derivatives to be credited or debited from this account. Learn all about dematerialisation and demat accounts.
  • Provide a cheque with the initial margin deposit for your margin account. You can use this balance to trade in the commodity market. The deposit amount may differ from broker to broker though. So, confirm the amount with the broker before opening a trading account.

Processing of your application

  • Document submission: If you have applied online, all your documents will be sent to the commodity broker’s head office for processing. Alternatively, you could submit the documents in person at the nearest branch office.
  • Account activation fee: The broker will charge a nominal account activation fee. If you happen to be opening an account with your existing broker, they might offer a fee reduction.
  • Processing time: The time taken to process your account opening application will differ from one commodity broker to another. Submitting the documents at the branch office is sometimes quicker as there is no lag in the documents reaching the broker.
  • Trading ID: Once the account is activated, the broker will create an account and a trading ID for you. You must now log in to your account and set a new password.

Getting started in commodity trading

Once your account is activated, you can start trading. Just ensure that your initial margin is reflected in your account. If not, then take this up with your broker immediately. Also, before you begin commodity trading, get acquainted with the margin calculator. Most brokers have such a calculator on their website. It allows you to check the total value of transactions that you can make against a given margin amount.

Also note that in case of derivatives, the gain or loss on a trade shows up in your margin account. Should you make consecutive losses, your margin account will dip. You will then have to add more funds to continue trading. On the other hand, if you profit from a trade, you can exit the trade to collect the profits.