Commodity Trading Strategies in India

Commodity trading in India facilitates the trade of products between farmers, traders, agri-businesses, corporates, and investors. The commodities market presents several opportunities to traders; however, having sound strategies in place before trading commodities is important. A commodity trading strategy can help you identify, enter, and exit trades in a systematic manner.

Along with spot trading, market participants can use instruments such as futures and options to buy or sell a commodity and hedge their existing positions. Exchange-traded funds (ETFs) help investors place long-term bets on commodities. In this article, we will explore some of the best commodity trading strategies.

Best Strategies for Commodity Trading

Let’s explore some of the best commodity trading strategies.

Trend Following Strategy

Commodity prices often move in a particular direction either, for a short term or longer duration. Traders can identify these trends by plotting trend lines or using moving averages. Traders can also use momentum indicators like the RSI. While following a trend, managing your risk and having trailing stop-loss orders to book profits when the trend reverses is important.

Range Trading Strategy

At times, a commodity’s price may move between two levels. Traders can capitalise on this range-bound movement by identifying the support and resistance levels. Indicators like the RSI and Stochastic indicator may aid in identifying overbought and oversold zones.

Breakout Trading Strategy

The price of a commodity may break out after trading in a particular range or pattern. The breakout trading strategy aims to capitalise on the momentum following the breakout. Traders should identify breakouts and check the volume to confirm the breakout. High volumes could indicate that there is a higher chance of the breakout being successful. One could enter into a trade immediately after a breakout or when the price retests the breakout level. Manage your position sizing and set a stop loss order accordingly. 

Hedging Strategy

Hedging in commodity markets is useful for farmers or traders who want to protect themselves from price volatility. A hedge is used to offset the losses in case the price moves against their position. A hedge is initiated by taking a contrary position using a different instrument or investing in an alternate asset. For example, a farmer believes the price of wheat will increase. As a hedge, the farmer shorts futures contracts of wheat in case the price of wheat declines in the future. If the price of wheat falls, the losses of the wheat position will be offset by the gains in the short position in futures.

Arbitrage Strategy

Another popular commodity trading strategy involves the use of arbitrage. Under an arbitrage strategy, traders benefit from the difference in price of a commodity in different markets. Suppose a commodity is trading at a different price in a different market. In that case, a trader can buy the commodity in one market and sell it in the other, pocketing the difference. Spatial arbitrage can be conducted in geographically different markets, temporal arbitrage makes use of pricing differences over time, or quantitative and statistical models can be used for arbitrage opportunities as well.

Seasonal Strategy

A seasonal strategy is a commodity trading strategy that leverages seasonal price trends in commodities. Traders can make use of historical data, weather trends, and seasonal demand forecasts to plan and enter into trades. Traders should track harvest seasons and the yield of the commodities for more insights.

Factors Affecting Commodity Prices

The right strategies can help traders and investors capitalise on a commodity's price movements. However, there are other factors that affect the price of a commodity.

Demand and Supply Dynamics

Similar to most markets, the forces of supply and demand play a crucial role in determining the price of a commodity. When the demand for a commodity is higher than its supply, the price of the commodity increases and vice versa.

Macroeconomic Indicators

Macroeconomic indicators such as inflation, interest rates, and GDP have a significant impact on the price of a commodity. A rise in inflation reduces the purchasing power. As a result, commodities become expensive. Higher interest rates make borrowing expensive, it can reduce demand for commodities, resulting in lower commodity prices. GDP growth can boost production and demand, making commodities more expensive and vice versa.

Geopolitical Events & Policy Changes

Changes in government policies like taxes and tariffs may again impact commodity prices and international trade as well. Additionally, geopolitical events like wars or political instability may lead to supply chain disruptions and increase the prices of commodities.

Weather Conditions & Natural Disasters

Weather conditions like droughts may lead to lower agricultural crop yields and increase prices. Natural disasters like floods, earthquakes, or wildfires can also damage production and drive up the prices of commodities.

Fundamental Analysis for Commodity Trading

One can make use of fundamental analysis to analyse the commodities market. Fundamental analysis of the commodities market includes:

Analysing the supply and demand trends: Identifying a particular commodity’s long-term demand and supply trends can help traders capitalise on the price movement and capture the underlying trend.

Impact of economic reports: Economic reports like the consumer price index, producer price index, gross domestic product, and employment data can help gauge the overall condition of the market and inflation scenario.

Understanding seasonal trends: Certain products see a pickup in demand during particular seasons, while the demand declines in other seasons. Traders can build positions according to these seasonal trends.

Government policies and trade regulations: Certain policies or trade regulations may impact the production of specific products or affect international trade, which may positively or negatively affect prices.

Technical Analysis for Commodity Trading

Traders can make use of technical analysis for a more quantitative and data-oriented approach to the commodities market. Technical analysis of commodity markets includes:

•       Candlestick patterns like double tops, wedges, or triangles.
•       Indicators such as moving averages, Relative Strength Index (RSI), or Moving Average Convergence Divergence (MACD).
•       Trend lines, support, and resistance levels.

Risk Management in Commodity Trading

No strategy guarantees a 100% success rate and might still fail after meeting all criteria. Therefore, It is vital to manage your risk effectively to prevent substantial losses. A trader should set strict stop-loss and take profit orders. Although leverage may be helpful, it is important to use it wisely and manage your position sizing accordingly.

Common Mistakes to Avoid in Commodity Trading

New and experienced traders alike, make mistakes while trading commodities. Here are the common mistakes to avoid in commodity trading.

Do not trade on tips: Conduct your own fundamental and technical research before taking on a trade. Trading on tips may lead you to entering into the wrong trades at the wrong time.

Do not overleverage: Leverage can help generate large profits but may also result in equally large losses. It is important to use leverage safely.

Stick to your plan: Traders should stick to their trading plan. Be patient and enter or exit your trades as you have planned. Impulsive trading can lead to losses and may result in you missing out on good trades.

Avoid overtrading: Overtrading or revenge trading can not only impact your psychology but can also eat away at your capital. Costs like brokerage, fees, and taxes pile up with more trades.

Do not ignore news and reports: Commodities are impacted by several domestic and global factors. It is important to keep track of the latest developments, and reports.

Final Thoughts

Having a good strategy for commodity trading can help traders to capitalise on trends or seasonal demand. Farmers and agri-businesses can use these strategies to hedge their position or benefit through arbitrage opportunities. However, it is important to know that no strategy is perfect. Strategies may fail sometimes and it is important to manage your risk, refine your strategy, and keep learning to become a better trader.