Beginners Guide To Commodity Market

Beginners Guide To Commodity Market

The commodity market is just like another market which is regulated by a certain set of rules. But it is different from the share market as in this market physical goods are traded.  In this market, weather plays an important role as most of the products that are ideal here are of agricultural products like wheat, rice, cotton, etc.

The commodity market is the place where the product or commodities are sold or bought.  It has been in existence from ages as it is one of the oldest markets, unlike the digital currency market which has been formed in recent years. In the digital currency market, various cryptocurrencies like bitcoin, litecoin, etc are traded and are emerging as one of the most popular markets in the world. You can read all about it here to get a better understanding of the workings of the market.

The commodities that are traded in the market are broadly classified into four- metals (copper, aluminum, etc), agriculture (cereals, pulses, etc), energy (crude oil and natural gas)and billions (silver, gold). There are varied types of contracts in the commodity market and these are the commonly used terms in the commodity market. They are futures contracts and forward contracts.

Futures contract- These contracts are entered between two different parties who promise to sell or buy an asset at a pre-determined price at a particular date.  The delivery and the payment of that asset will be done on a future date and it is called as the delivery date. A buyer in the contract will be holding a long position while the seller in the contract will hold a short position.

Forward contract- In forwarding contract, it is an agreement entered between 2 parties who buy or sell the commodity in future at a fixed price. It helps in hedging the risk for the person who buys against any fluctuation at price and the seller gets a guaranteed price.

Many people have a misconception that both are similar, but they’re both are different in some ways.

  • The forward contracts get traded over the counter, whereas the future contracts get traded on exchanges.
  • In forward contracts, private negotiations are entertained.

The future contracts follow standard execution way and all the transactions get guaranteed by clearinghouse so that there will be fewer defaults on the agreement. Hedgers use the forward contracts as they want to eliminate the risk in pricing and the speculators use the futures contract who predicts the price movement of assets.