This post will explain Crude Oil Trading in detail. Factors affecting global crude prices are also discussed. Guidelines for effective Crude Oil Trade are covered as well.
What is Crude Oil?
Crude Oil is one of the most valuable natural resources. It is a major source of energy. Crude is refined into many different petroleum products before it reaches the end consumer.
Composition of Crude Oil
Crude Oil is comprised of that segment of world oil supply that is extracted from US soil. Its reserves are also found under water where offshore platforms need to be established for extraction. This extraction technique enhances cost but is widely used.
Post extraction phases
Crude is not at all useable when extracted. It is nothing but a dark black thick liquid. The oil is then shipped to refineries either through pipelines or vast oil tankers.
How is Crude Oil Traded?
Crude Oil is one of most actively traded commodities at Chicago Mercantile Exchange which is among the largest exchanges of the world. The 2 main modes of trading crude oil are:-
This trading is suited to those buyers and sellers who immediately want settlement. Spot counter is also known as ready market as there is almost no lag between transaction and delivery.
2. Futures Trading:-
Crude Oil futures contracts are widely traded across the globe. These are standardized contracts of 1,000 barrels each with an expiry of approximately 4 weeks.
The price of crude futures contracts are linked to spot price of crude which means that if spot price increases, so does the price of futures contracts.
Participants of Crude Oil Market:-
The major participants of this market are oil extraction companies who are pumping millions of barrels of crude oil each day into the global oil supply. They widely use crude futures contracts to hedge against oversupply concerns especially when they feel the prices to be overvalued.
Another key player is oil marketing companies (OMCs) who procure crude oil in view of expected demand of finished gasoline products. OMCs extensively use crude futures contracts to hedge against price risks and demand related concerns.
Then there are large hedge funds and speculators who craft earning opportunities from price fluctuations in the futures market. They improve the overall liquidity in the futures market by taking long or short positions based on their future price projections.
Marco-factors that affect global Crude Oil prices:-
• Projections for U.S crude oil production inversely relate to price as it creates oversupply concerns.
• Strong domestic demand in the U.S exerts upward pressure on crude prices.
• Seasonal supply disruptions caused by adverse weather push oil prices higher.
• Unforeseen supply troubles such as damage to oil pipelines result in price spikes.
• Political disturbance in major oil producing countries increase demand for US Crude.
• Military tensions or conflicts surrounding key oil producers hike oil prices.
Micro / US specific factors affecting Crude Oil prices:-
In addition to the above macro factors, there are a few variables specific to America.
1. Domestic US Demand:-
USA is among the world’s largest economies. This also makes it one of the major consumers of oil. Overall US demand is positively correlated with its economic health. If US economy is doing well, it implies a strong domestic demand for oil.
2. Shale boom of USA:-
Not long ago, America was one of the largest importers of oil. It was mainly due to 2 factors:-
a) As a strategic move, it did not want to consume its domestic crude oil reserves.
b) Shale technology initially was very expensive and importing oil was financially more viable.
This was followed by the shale boom of USA. Shale is a relatively new oil extraction technique which is effective for oil reserves that are geographically dispersed. Initially, shale technology was very expensive and lead times for setting up and dismantling oil rigs were much extended.
With extensive R&D in shale production, the technology not only became highly cost effective rather lead times for shale rigs were also drastically reduced. Shale was extensively adopted by all major US oil exploration companies and US oil production skyrocketed.
Presently, USA has become the largest global producer of oil which not long ago was an importer. This created many new markets for American crude which is now being supplied as far as Asia as it is strongly competitive.
3. US Crude Oil Inventories:-
Existing inventory levels in the USA and Crude Oil prices are inversely related. Rising inventories imply either increased supply or reduced demand. Crux of the matter is that increasing levels of crude inventories are not good for crude oil prices.
Two American agencies named American Petroleum Institute (API) and Energy Information Agency (EIA) release US inventories data on Tue and Wed of each week respectively. Data released by EIA is regarded as the official one and carries more weightage in the eyes of market players.
The released inventory data is compared with last week’s inventory levels. If crude oil inventory levels show a decline from previous week, it is perceived positively the markets. The fall in levels of inventory is attributed to strong demand both domestically and internationally.
4. Baker Hughes rig count:-
Another key data on crude oil production is released by Baker Hughes on Fri of each week. This is commonly known as Rig Count. This is a data of active oil rigs pumping oil in the USA and Canada.
If the number of active oil rigs increases as compared to the preceding week, it is implied that the demand / production has increased. This is perceived by the market participants as negative for crude prices and it creates oversupply jitters in the market. It is pertinent to note that only major variations in weekly rig count create high price volatility.
Correlation of US Dollar with Crude Oil Price:-
Dollar strength and crude oil prices have a negative correlation. It means that a strong or rising American dollar puts downward pressure on crude price. Reason is that as dollar gains in value, crude becomes costlier for buyers. This is particularly true in the short and mid-term. In the long term though, demand and supply play a decisive role.
Trading opportunities in Crude Oil:-
The above cited macro and micro factors create very high volatility in crude oil prices. This presents a major opportunity for speculators whether big or small. “Margin Trading” is extensively available in crude oil trading further enhancing prospects.
Prior to trading crude oil, it is imperative that all major variables are understood along with their imminent effect on price. The relative weightage of each factor in a given circumstance is also vital for successfully trading in crude oil. Being a highly volatile commodity, it is strongly advised that Crude Oil Trading be done with proper risk management in place.
This post covers Gold Trading, its types and factors that affect international gold prices. Types of Gold Trading are also discussed in good detail.
Intro to Gold
Gold is among the oldest medium of exchange known to man. Before paper and plastic money, gold and silver coins were used to purchase items. The role of gold as a “currency” gradually declined but its inherent character as a “store of value” is quite intact.
Historic Value of Gold
Gold was among the leading yardsticks for the overall opulence of nations. Many wars were fought just for the sake of this precious yellow metal. Countries around the world still maintain gold reserves in the event of unforeseen circumstances.
Not too long ago, countries could print paper money strictly according to their national gold reserves. It was later decided that money supply in the economy be delinked from gold reserves. This resulted in rapid proliferation of paper and plastic money that led to many allied problems.
Present role of Gold
Gold has now attained the status of a globally recognized precious metal. Irrespective of its redundancy as a medium of day to day exchange, its importance has grown over time.
Gold as a Commodity
Gold is not merely vital for countries; rather it is also valued by the common man as a genuine and reliable store of value. The same cannot be said about paper money as it keeps losing its intrinsic value owing to many other factors.
Correlation of Gold with Inflation
Inflation is the phenomenon whereby prices of items in any economy start rising. It is an undeniable fact that some inflation is good, rather vital for any economy. It is when inflation heats up the economy to an extent that paper money starts losing its buying power too rapidly.
In order to preserve the intrinsic value of money, people tend to “park” their wealth in alternative avenues. Investment in gold is a historically proven recipe to tackle adverse effects of inflationary pressures.
How Gold Trading Takes Place
Gold is an internationally traded commodity listed at all prominent exchanges. Its value in denoted in US $ and standard unit of measurement is US Troy Ounce. Bulk of gold trade now takes place electronically.
Types of Gold Trading
Gold trading can be broadly categorized into the following 2 types:-
1. Spot Trading:-
Gold is readily bought and sold at prevailing price but this mode entails full payment and physical delivery.
• A buyer opting spot price will pay the entire amount in cash and obtain physical delivery of purchased quantity in a couple days or so.
• A trader who sells gold at spot price must physically possess it at the time of selling as he is mandated to deliver sold quantity of gold to the exchange.
2. Futures Trading:-
Major gold trade takes place in futures contracts. These are standardized contracts with pre-defined date of expiry. Lot size is also uniform at 100 US Troy Ounce. To facilitate small traders, most commodity brokers offer mini lots of gold futures contracts as well.
Future trading of gold does not entail physical delivery at any stage. For this reason, futures contracts are “cash settled”. Upon close of trade, the trader either makes a cash profit or incurs a loss which is reflected in running balance of his futures trading account.
Mechanics of Gold Futures Trading
Traders have varying perceptions about future outlook of gold prices but the 2 most prominent ones are:-
This lot believes that future price of gold would increase. So, they purchase future contracts of gold with the hope of selling those at a higher price.
They believe the current price is not sustainable or overvalued, so they sell contracts in advance with the expectation of a drop in price. If price actually drops, this translates into monetary gain for such traders.
Factors affecting International Gold Prices
Some of the most vital factors that influence gold prices internationally are discussed below:-
• Gold is considered a “safe haven” in times of turmoil whether political or military.
• Uncertainty over the outcome of major international events also fares well for gold prices.
• Military standoffs between key international players also enhance gold demand.
• Whenever interest rates are reduced by key central banks, this makes gold more attractive instead of fixed income avenues.
• Inflation and gold demand have a positive correlation as people rush to buy gold to hedge against imminent loss of value.
• Gold demand sees a noticeable spike when the overall economy is showing signs of slackness.
• When major economic powers are building gold reserves, this exerts noticeable upward pressure on gold prices.
• Prolonged selloffs in equity markets trigger gold demand as people look for cover.
• Declining bond yields also tend to improve overall prospects for shifting to gold.
▪ Gold is an excellent hedge against inflation.
▪ In times of uncertainty, it is prudent to park one’s money in gold.
▪ Future trading in gold with proper risk management presents many lucrative earning opportunities
This post will discuss Margin Trading in detail. Its pros and cons are also covered at length.
Methods of Trading
There are 2 main ways to trade in the market:-
1. Cash Based
A trader deposits full value of the item he is trading. This mode is quite uncommon among traders as it is capital intensive.
2. Margin Based
As the name suggests, this trading is done on “Margins”. A trader opens a margin trading account with any exchange through a broker.
What is Margin Trading?
To better understand margin trading, let’s consider a simple example. A commodity is trading at 100 $ at Chicago Mercantile Exchange. Margin trading is allowed in this commodity. The exchange has set 5% margin for this item. It implies that in order to buy or sell 100 $ worth of this commodity, any trader must have a minimum deposit of 5 $ in his margin trading account.
Margin is also known as Initial Margin. So, the trader has bought 100 $ worth of commodity contracts by placing a mere 5 $ in his trading account. If he wants to enhance his holding to 200 $, he would simply deposit another 5 $ and purchase an additional 100 $ worth of this item and so on.
The concept of margin trading is quite simple to this extent. However, it gets tricky from hereon. Let’s assume the market price of that commodity drops to 98 $. How will this affect the margin trading account? The 2 $ drop in market price will eat into the 5 $ initial margin placed by the trader, which is now reduced to 3 $.
What is a Margin Call?
The balance in trader’s margin account has dropped from the mandatory 5 $ mark. This generates a “Margin Call” in his account. The broker concerned contacts the trader and informs him of this 2 $ shortfall. The trader has 2 alternatives at this stage; either he deposits an additional 2 $ in his trading account or he reduces his position.
The trader’s decision relies upon his perception about future price trend. If he thinks that this 2 $ drop in price from 100 $ is temporary, he will prefer to deposit an additional 2 $ to sustain his position. If he infers that this price drop is likely to continue or even escalate, he will be inclined to “book” this 2 $ loss and liquidate his position.
If the trader decides to add funds to his trading account to sustain this position and the price downfall continues, the above cycle of margin calls will continue and he would have to keep adding funds to the tune of subsequent margin calls.
If he decides not to add funds and book his losses, he would sell his position at 98 $ price. The balance in his margin trading account has now dropped to 3 $ from 5 $. Now, he would search for another trading opportunity and try to make up his losses elsewhere or at some other time.
Advantages of Margin Trading
• This provision enables traders with very small capital to actively participate in the market.
• Margin enables traders to take positions far exceeding their invested capital, anywhere between 20 to 1,000 times of their deposit.
• A good trade can result in landslide profits which are inconceivable in relation to one’s contributed capital.
Cons of Margin Trading
• Most traders fail to grasp the “gravity” of the situation that they are trading on such high risk.
• Risk is directly proportional to level of leverage but most traders do not see the flip side.
• A trader may get stuck in a bad trade and keep meeting his margin calls without realizing that booking his loss beyond a certain stage is a better alternative.
• Poorly managed margin accounts can potentially wipeout a trader’s entire capital.
• Overwhelming majority of margin traders are losers due to improper risk management.
How to manage a Margin Trading Account
As discussed earlier, allowed margins may range between 20 to 1,000 times of one’s actual investment. Apparently, this seems like a great money minting opportunity but most traders fail to see the flip side. There are 2 main strategies to better manage a margin trading account:-
1. Cautious Use of Margin
An exchange allows you to trade 20 times of your capital. Why utilize all of it? A trader should not exceed 2-5 times of his capital. Routine trading should be done only with your own capital without employing margin at all. If a good trading opportunity presents itself, it may be enhanced to 2-5 times to improve earnings prospects but not beyond that.
It has 2 key advantages, first being the total avoidance of troubling margin calls. Even if the price moves unfavorable, there would be ample cushion in the margin account to sustain this jolt. There is no question of auto/forced liquidation of the position as there is sufficient margin to avert this.
Lastly, if there is no margin call, the trader can easily avail small price swings by circulating his position repeatedly. This option is ruled out in case there is a margin call in the account. A position once liquidated under margin call cannot be rebuilt fully unless fresh margin is added.
2. Trading with strict Stop loss
This is another good strategy if margins are being heavily availed. If a trader has utilized most of his allowed margin, room for error is minimal. Under this condition, if the price moves slightly against the trader’s position, the account is likely to be wiped out. So, a strict stop loss should be employed so that the trading account does not sustain irreparable losses. By using this option effectively, you as a trader will live to fight another day.
What is Auto-Liquidation?
This is a closely related issue to margin trading. As per exchange laws, initial margin has to be fully maintained by all traders. Some traders tend to ignore margin calls in their accounts. So, exchanges have come up with auto-liquidation mechanisms. When the running margin in a trader’s account falls to a certain pre-defined threshold, an example can be 21% of required initial margin, the trader’s open position is auto-liquidated.
Auto-liquidation laws exist in all exchanges in some form or the other. They act as a last line of defense for the exchange and trader. The main purpose of auto-liquidation mechanisms is to come into play before a trading account goes into negative territory, after all the initial margin has been eroded.
Margin trading is a tricky affair and most traders jump into this arena without considering the pros and cons. It is a double edged weapon and must be used with extreme caution.
Guidelines for managing Margin Trading accounts are covered in detail.
This post will cover Technical Analysis and a few tools.
What is the need for Technical Analysis?
There are many classes of traders in any exchange / market. Whether small or big, every trader aims to anticipate the price trend of his instrument. A correctly read trend can translate into huge financial gains. The ability to trade most items on “Margins” further magnifies earning prospects in which traders take positions far exceeding their actual investment. Although this also enhances risk but if the trend is captured correctly, the rewards outweigh it.
This strong urge in traders whereby they can read the future price trend of any financial instrument be it stock, commodity or index etc. acts as a driving force behind technical analysis. There are two main schools of thought about price trend. One believes that price movement is entirely random and it cannot be projected. Traders belonging to this segment do not give much weight to technical analysis. They mainly trade on news and other random developments.
The other school of thought strongly believes that price movements are not a mere random event and that there are certain underlying laws that play a part. It is consolidated by the belief that past price trend holds the key to unlocking future price inclinations.
It is also strongly believed by technical analysts that the current price of any traded instrument has fully discounted all invisible factors. So, instead of wasting one’s resources on gathering news and other info, prime focus should rather be on technical indicators.
How is Technical Analysis Performed?
The cornerstone of any such analysis is data on past price trends. The accuracy of historical price data is of paramount importance as distorted inputs will predict unreliable future trends. The next question is how far back in history should one go. This is also a subjective matter as traders tend to take positions over different time horizons. This mainly relies on the individual temperament of each trader.
One trader may have a timeframe of 6 months for a particular item. Another speculator may not want his position to exceed two working days for the same instrument. The timeline for trading also depends upon one’s ambition. If a trader wants to make landslide gains, he would most likely have to opt for a longer time period and vice versa.
Additional Factors in Technical Analysis
Past prices data is only one of the inputs employed in technical analysis. A few additional factors include traded volume, seasonal trend and correlation with other traded instruments. The nature of this correlation (if any) may be positive or negative; it is important nonetheless.
What are key Technical Analysis Tools?
Over time, hundreds and thousands of technical analysis tools have been formulated by very talented mathematicians and statisticians. Tweaks to existing tools have led to many modified versions of the same analytical tool. Some of the most reliable and famous ones are discussed below:-
1. Moving Average:-
This is one of the oldest and most reliable technical analysis tools. The rule of thumb for this tool is that if the price of any instrument is trading above a moving average, it is in bullish territory. Further, when
price has appreciated way above it and stalls from there, the moving average will act as a good support. The opposite is believed to be true for declining prices.
If the price falls below a moving average, it is said to have entered into bearish territory. However, when the price has declined sharply from any moving average, it shall now act as a major resistance in case of recovery.
The most reliable moving average is one based on closing price of the instrument. For instance if 20 days moving average has been applied, its value will represent average of the last 20 day’s closing prices of that item. Apart from close, the tool can also be applied on asking price and so on. This would however reduce its accuracy.
The few globally accepted moving average timelines are 20, 50 and 200 days moving average (M.A). Each is suited to a different class of trader depending upon his temperament and objectives.
2. Relative Strength Index (RSI):-
RSI is also among the globally acknowledged technical indicators. Its value ranged from 0-100. There are 3 crucial values to monitor which are 30, 50 and 70. Like the MA, RSI is most reliable when applied to closing prices. In theory, price and RSI are positively correlated. Rise in price tends to increase RSI.
The RSI range of 0-30 is believed to depict an oversold condition. It implies that the instrument is ripe for buying at this stage. RSI value of 50 or close reflects a pivotal stage for future price trend. If RSI fails to breach this mark when price is recovering, prices are likely to stall again from this stage.
If price keeps increasing and RSI successfully breaks the 50 mark, the price has entered a bullish zone. So, traders either make fresh buy entry or hold on to their long positions at this stage.
RSI value of 70-100 reflects an overbought state. It indicates that price may stall from these heights. So, at this stage, traders tend to book their profits from long positions. They may also short sell the instrument at this stage, hoping for a decline in price due to the overbought conditions.
3. Fibonacci Retracement (Fib):-
This is a model that is considered quite reliable by many traders. It is named after the mathematician who derived it. This is based on the hypothesis that prices always move in pre-defined bands. Total span of the wave is defined by a prominent peak and low over a defined time line. The accuracy of this model is directly proportional to the timeline.
Once a prominent high and low have been identified, they form a complete wave. The model further states that the price will retrace its previous path, upward or downward, not randomly; rather in steps of predefined ratios. The most famous fib ratios are .236, .382, .5, .618 and .786.
The idea behind this model is that whether price is on uptrend or otherwise, it will face resistance around these values derived through above fib ratios. So, the trader should closely watch price behavior around the critical fib ratios and take trading decisions accordingly.
Example of Fib Model:-
After making a low, when the price crosses .236, the low is said to have been established. When .382 is crossed, price enters bullish phase. It may face some resistance at .5 but .618 is a major resistance. It is quite likely that price may fall back to .382 from .618. This phenomenon is known as technical correction. As soon as price crosses .618, it may face resistance at .786. If .786 is also crossed, it is quite likely that the recent high would be tested again. It is to be closely seen whether price successfully makes a new high or stalls around it.
Conclusion on Technical Analysis:-
Technical analysis tools are indeed a boon for traders. It is imperative to hone one’s skill in interpreting these indicators correctly and timely. The critical factor however is a trader’s ability to take decisions in line with signals generated by these indicators. Most traders tend to ignore these indicators and sway with their personal likes and dislikes.
This post sheds light on Technical Analysis. I have also discussed its importance and few globally recognized technical analysis tools.
This post covers an Equity Index, its composition and other aspects. Factors affecting index value are
covered as well.
Intro to Equity Market
Any new business is in dire need of funds. The critical cash is required for consolidating and expanding
the entity. The phase of R&D commences through which existing processes and products are improved.
Innovative services and goods are produced from this investment.
Sources of Financing
Any emerging business mainly relies upon 2 sources of raising funds:-
Financial lending institutions are approached to raise funds. There are two main drawbacks to this
option. First, the business has to provide some tangible collateral / security to obtain loan. This is at
times impossible to arrange. Secondly, interest has to be paid on debt / loan, irrespective of
whether the business earns a profit or not.
Including debt in the financing of business increases its flight weight. It often results in businesses
going bankrupt even before takeoff. Most entities avoid including debt in the infancy stage.
A promising business startup lists itself on the equity / stock market. It sells its business model to the
general public and invites them to become shareholders. If the masses see promising prospects in
the company, they buy its shares / stock. In turn, the company gets much needed funds. The stock
buyers become stakeholders in that company.
The advantage of including equity is that the business is not bound to pay any interest on this
money. Shareholders are paid only if the business makes a profit. The other imminent advantage for
stock holders is capital gains. If an entity earns good profits, its stock soars in the equity market.
What is an Equity Index?
There are countless listed companies on any stock exchange. At times, a single company is simultaneously
listed and traded on multiple exchanges. These companies belong to various sectors. Some may be
involved in manufacturing while others are in services.
This diversity presents a challenge for active equity traders. One such trader may only be interested in
stocks of oil marketing companies. Another trader might be involved in stocks of only tech companies.
This resulted in the need for equity indices.
An equity index does not have any intrinsic value; rather its value is derived from its constituent stocks.
Let’s assume a technology stock index. This index is comprised solely of tech companies stocks. After
defining qualifying criteria for an index, relevant stocks fulfilling it are added to that index.
Common Criteria for an Index
1. Capitalization Based
This type of index is independent of sectors of its constituent stocks. It may include a tech stock as
well as service sector firm. If the company’s market cap is more than a defined threshold, it qualifies
to be included in that index. Each constituent stock is awarded a weight-age in such index directly proportional to market cap. Higher a stock’s cap, greater is its weight.
2. Sector Based
This index is composed of stocks belonging to a predefined sector. For instance a tech related index
will be composed entirely of technology stocks. Another service sector index will be composed
entirely of stocks of companies providing services.
How Index Value Changes
The value of any index changes with fluctuation in the stock price of its constituent stocks. If price of most
stocks in an index is on the rise, the value of index will appreciate and vice versa. The change in index
value will be proportionate to the weight of each stock in that index.
Advantage of Trading an Index
There is an incentive in trading an index instead of individual stocks. A single stock is highly prone to
volatile price swings. They are caused due to rapid changes in the market sentiment. Perception of
majority traders also affects stock price. The short to medium term future outlook of the company also
leaves an impact.
Since an index is composed of many stocks, it is quite well immune from factors affecting the price of
individual stocks. Therefore, an index is a far more reliable gauge for a particular sector instead of any
individual company’s stock no matter how reputed.
How is Equities Index Traded?
All major exchanges allow trade in equity indices. Futures contracts exist for such indices. Traders may
take long (buy) or short (sell) positions in any index of their liking based on their future assessment.
Margin trading facility is also extended for trading indices.
This post covers internationally traded commodities and their salient features. Factors affecting their
price are also covered.
Into to Commodities
Commodities date back to the time of barter trade. In that era, items of necessity were directly
exchanged and no paper money was involved. Initially, the most valuable commodities were crops / food
items. Gradually, gold and silver coins were introduced which laid the foundation of money as a medium
of exchange. Now, items could be exchanged for silver and gold.
With the industrial revolution and better technology, many new metals were discovered. Advances in
chemistry led to many new metals from existing ones. Many alloys were also created. Sources of energy
such as oil and natural gas were also discovered across the globe.
The world has now become a global village. Gone are days when individual nations were the sole
producers and consumers of any commodity. International trade is an inescapable reality. Each country,
no matter how resourceful, is dependent on another for natural resources.
Birth of Commodities Market
Back in time, villages were the basic unit of bilateral trade. A wheat farmer would bring his produce to
the village town hall and seek to exchange it for rice. As agriculture became mechanized, production
This led to the need for structured commodity markets at national level where prices of commodities
were ascertained for all producers. As means of transport improved, the outreach of commodities also
increased. An item produced in Europe could easily be shipped to Asia irrespective of size.
As internet prospered, commodity markets achieved global scale. Today, the Chicago Mercantile
Exchange in U.S.A is among the oldest and largest commodity exchanges of the world.
Evolution of Commodity Markets
As business volume at commodity exchanges increased, so did the need for standardization and
regulation. A set of qualifying criteria were defined for each commodity so that only the ones meeting
those benchmarks could be traded.
Considering the production of each commodity, standardized lot sizes were introduced for each
commodity. For instance Gold, a precious metal, is traded all across the globe in ounces (oz). The
internationally set lot size for trading gold is 100 troy ounces. If a trader wants to accumulate more than a
100 oz, he would have to purchase more lots of 100 oz each.
Role of Commodity Markets
In order to understand the role of commodity markets in the economy, visualize the most basic model of
a ‘producer’ and ‘consumer’. On one end lies a cotton farmer who wants to sell his crop at the best
possible price. At the other end lies a textile unit that needs the cotton as raw material. Both the farmer
and industrialist are concerned about their best interests.
Commodity markets act as a bridge between the above cited producer and consumer. Both will approach
the commodities market that will ensure the farmer gets his due price. It is equally vital that the
consumer is not ripped off as his viability depends on procuring raw materials cost effectively.
Modern Commodity Exchanges
Today’s commodity exchanges are fully electronic where commodities worth billions change hands within
seconds. Uniform contracts with pre-defined expiry are regulated by exchanges. Universal lot sizes are
defined for each commodity creating ease for traders.
A cotton farmer expects his crop to be ready in the coming 2 months. He is also concerned whether ho
would fetch a good price for his efforts. So, he heads to the most feasible commodity exchange. He looks
up the price of relevant futures contract for cotton. As soon as he is satisfied with the price, he will sell
contracts of cotton in line with his expected produce.
A textile unit owner receives an order of finished cotton shirts from one of his clients. The delivery has to
be made in the next 3 months. He needs cotton as his primary raw material. As a producer, he is rightly
concerned about the supply of cotton over the next 2 months. Supply constraints may propel the price of
raw cotton higher, making his order unfeasible. So, he would go to the commodity exchange and place a
purchase order for cotton in the relevant contract. Now, he has secured his future supply of cotton at a
price of his liking today.
The commodity exchange acts as a guarantor for both parties. As soon as the farmer delivers his produce
to the exchange, he is paid as per his selling price. When the consumer receives delivery of his purchased
cotton, he makes the payment as per his purchase price.
Role of Speculators in Commodity Market
Producers and consumers are the main participants of commodity exchanges. There is another key player
known as ‘speculators’. They are the reason for most daily price volatility. Traders aim to create earning
opportunities from price movements. To facilitate traders, they are provided financing in the form of
We are firm believers that skillful traders aren’t born, they’re trained — which is why we place emphasis on providing a wide range of free educational resources to start your trading journey off on the right foot.
However, while learning how to navigate your platform and becoming familiar with different analytical tools is incredibly important, there are several other traits you’ll need to work hard to develop in order to potentially become a successful trader.
This is an important one! The financial markets provide an overwhelming amount of choice. With thousands of different financial instruments to opt for and 24 hours a day to trade them, it can be easy to invest in more than you should, putting your capital at risk. Experienced traders typically take a more disciplined approach and focus on a more limited group, such as three or four trading instruments. This gives you more time to be on the alert for trading signals, instead of getting carried away and adjusting a dozen trades at random.
Ever heard the saying patience is a virtue? In trading, it’s more than that – it’s a must! The market behaves differently every day, with no two trading days alike. This means that sometimes you’ll have to wait patiently until the conditions are right to take action, which prevents you from opening or closing a trade too soon in frustration.
The ability to stay calm under pressure is another essential skill you’ll need. Whether the particular cause is an economic or political event, the markets can react with sudden volatility. In order to achieve the best possible result, you’ll need to battle panic and the fear of missing out to protect your investment — let alone potentially profit from it.
In the ever-changing financial markets, traders need to develop a highly resilient state of mind, to take on challenges and make use of them as valuable learning experiences. Resilience enables traders to perceive losses or setbacks as a vital part of the trading journey and build a strong mental outlook that is driven by problem-solving.
Although a tried and tested trading strategy is an important part of your toolkit, you’ll need to remain open to adapting it over time. A technique that worked for you 3 months ago won’t necessarily continue to present the same results. Even a veteran trader will continue to explore and test out new strategies, knowing full well that the markets are constantly on the move.