Introduction to currency and commodity markets

After reading through plenty of equity and equity-related markets, let’s switch our focus for a bit and take a look at two other financial markets - currency and commodity markets. In India, these two financial markets may not really enjoy the same level of admiration and popularity that equity markets have. However, they are still quickly gaining traction among traders in the general public. 

Here’s an introduction to both the currency and the commodity markets.      

Currency market: An overview

What is a currency market? Well, simply put, a financial market where a wide variety of currencies are bought and sold is termed as a ‘currency market.’ In the world of finance, it is also commonly referred to as a foreign exchange market or a FOREX market. 

And here’s a fun fact for you. The currency market is the largest financial market in the entire world, with an average trading volume of around $5 trillion each day.   

As you must have already read in the first module, the currency market is an over-the-counter (OTC) financial market. This effectively means that the trades do not happen through an exchange. Instead, they happen directly between the buyer and the seller. 

More about currency markets

The entire market is operated by a huge network of banks throughout the world. There are four major forex trading centres in the world, located in the following cities.

• Tokyo
• Sydney
• New York
• London

Since the foreign exchange market is an OTC market, it has no centralised location and it is open round-the-clock, for all the 24 hours in a day, from Monday to Friday. 

In the forex market, since you buy one currency and sell another, currencies are always quoted in pairs. For instance, the USD-INR is a currency pair, where the USD is known as the ‘base’ currency and the INR is known as the ‘quote’ currency. The base currency is what you buy and the quote currency is what you sell. 

So, when you’re trading in the USD-INR currency pair, you’re actually buying the U.S. dollar and selling the Indian rupee. Sort of like a barter.   

Just like equities, the foreign exchange market also has a vibrant derivative market of its own, with currency futures and currency options being two of the contracts available for trade. These contracts derive their value from the underlying currency.   

Commodities market: An overview

What is a commodities market? In simple terms, the commodities market is another financial market where both agricultural and non-agricultural commodities are bought and sold. Some of the non-agricultural commodities that are traded include gold, silver, crude oil and copper, among other things. Agricultural commodities that are bought and sold on the commodities market include wheat, pepper, castorseed, sugar, almond and cotton, among others. 

Similar to equities, the commodity market is an exchange-regulated market, where the commodities are bought and sold through an exchange. 

Here’s another quick fact for you. In India, there are six major commodity trading exchanges currently in operation. 

1. Multi Commodity Exchange – MCX
2. National Commodity and Derivatives Exchange – NCDEX
3. Indian Commodity Exchange – ICEX
4. The Universal Commodity Exchange – UCX
5. Ace Derivatives Exchange – ACE
6. National Multi Commodity Exchange – NMCE

More about commodity markets

Again, just like the equity market, there are two segments to the commodities market - the cash segment and the derivatives segment. The derivatives segment includes both commodity futures and commodity options. 

When you buy a commodity in the cash segment and the trade is executed between you and the seller, the seller becomes responsible for physically delivering the said commodity to you, the buyer. In turn, you are responsible for receiving the said commodity and storing it. 

Let’s take up an example to better understand how a direct investment in commodities works. 

Assume that you’re a buyer looking to buy a gram of gold. You find a seller through the commodity exchange and the trade gets executed. Now, the seller is responsible for safely delivering the gram of gold to you. As the buyer, it is your responsibility to receive the physical delivery of gold and store it safely. 

Since this example deals with just one gram of gold, physical delivery might seem quite practical. However, when you’re dealing in kilograms of a certain commodity, physical delivery quickly becomes a hassle and in some cases, even completely impractical. This is one of the main reasons why the majority of trades in the commodity market are primarily from the derivative segment, where the contracts are cash-settled and there’s no physical delivery involved.  

Wrapping up

All of this is pretty interesting, isn’t it? Our module on currencies and commodities will delve even deeper into these two financial markets. For now, let’s proceed to learning about how you can build the right portfolio for yourself.

A quick recap

• A financial market where a wide variety of currencies are bought and sold is termed as a ‘currency market.’
• In the world of finance, it is also commonly referred to as a foreign exchange market or a FOREX market.
• The currency market is an over-the-counter (OTC) financial market. This effectively means that the trades do not happen through an exchange. Instead, they happen directly between the buyer and the seller.
• Since the foreign exchange market is an OTC market, it has no centralised location and it is open round-the-clock, for all the 24 hours in a day.
• The commodities market is another financial market where both agricultural and non-agricultural commodities are bought and sold.
• Similar to equities, the commodity market is an exchange-regulated market, where the commodities are bought and sold through an exchange.
• In India, there are six major commodity trading exchanges currently in operation.