How commodity trading works ?
Do you think gold prices will go up further?
Are you sure that crude oil prices are going to fall?
Have you heard that the soya crop this year is bad and will result in soya prices going up?
If you believe that these predictions have a good chance of coming true and are willing to bet some money on them, you could try your hand at playing the commodity futures market.
In How to trade in Futures, we spoke about stock futures. Here we talk about commodity futures.
The commodity markets have changed a lot from the poky, little hole-in-the-wall trading offices in narrow streets next to crowded markets where traditional dhoti-clad merchants used to trade.
Brand new commodities exchanges the main ones are NCDEX and MCX have been set up and these are fully computerised.
More and more stock brokers are setting up commodity brokerages as well, and trading volumes in commodity futures is widely predicted to rival the volume of derivative transactions (futures and options) on the stock exchanges.
What's more, you can also trade online.
Why commodities trading?
Well, let's suppose you want to buy gold because you believe that the price of gold will rise.
You could then buy gold ingots, store them, wait for them to go up in price, and then sell them at a profit.
But, you have to be sure that the gold you buy is pure, you have to find a place to store it, you have to provide the security, transport it to vault and other such hassles.A far better way to invest in gold would be to buy gold futures from the commodities exchange.
How do you do that?
When you buy a Gold Futures contract, you undertake to do three things.
1. Buy the amount of gold specified in the contract.
2. Buy it at the price specified in the contract.
3. Buy it on the expiry of the contract. This could be after one month, two months, three months and so on. Of course, if you sell the Gold Futures contract before it expires, then you don't have to worry about actually buying the gold.
Let's say you buy the Gold Future contract at say Rs 7,200 per 10 gm.
Your hunch comes true and the gold prices rally to Rs 8,000 per 10 gm.
You can sell the Gold Futures any time before expiry of the contract.
Gold and other commodity futures prices are quoted on the commodity exchanges in exactly the same way in which stock prices or stock futures prices are quoted on a daily basis in the stock markets.
How it works
Just like stock futures (Read How to trade in Futures to understand how futures work).
When you buy a Futures, you don't have to pay the entire amount, just a fixed percentage of the cost. This is known as the margin.
Let's say you are buying a Gold Futures contract. The minimum contract size for a gold future is 100 gms. 100 gms of gold may be worth Rs 72,000.
The margin for gold set by MCX is 3.5%. So you only end up paying Rs 2,520.
The low margin means that you can buy futures representing a large amount of gold by paying only a fraction of the price.
So you bought the Gold Futures contract when it was Rs 72,000 per 100 gms.
The next day, the price of gold rose to Rs 73,000 per 100 gms.
Rs 1,000 (Rs 73,000 – Rs 72,000) will be credited to your account.
The following day, the price dips to Rs 72,500.
Rs 500 will get debited from your account (Rs 73,000 - Rs 72,500).
What you need to know
Compared to stocks, trading in commodities is much cheaper, because margins are much lower than in stock futures.
Brokerage is low for commodity futures. It ranges from 0.05% to 0.12%.
Because of this, commodity futures are a speculator's paradise.
If you are a hard-core trader who follows the technical charts and do not really care what you trade, and if you are nimble and savvy, then commodity futures could be another asset class that you would be interested in.
The advantages in this line is that there are no balance sheets, no complicated financial statements----all you have to do is follow the supply and demand position of the commodities you trade in very closely.
Go onto the commodities trading exchange - NCDEX and MCX - to see which commodities are offered for trading, their contract size and other criteria. You will have to get hold of a commodities broker but that should not be a problem. There are lots of brokers that offer commodity trading these days.
But, it would be wise to avoid commodity trading if you are a rookie. A better move would be to initially trade in stock futures before opting for commodity futures.
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What is Market Capitalization?
When you are talking about the “mid-cap”, “small-cap” and “large-cap” stocks, you are actually talking about talking about market capitalization!
Market capitalization (market cap) is a measurement of the size of a business enterprise (corporation) equal to the share price times the number of shares outstanding (shares that have been authorized, issued, and purchased by investors) of a publicly traded company.
Market cap or market capitalization is simply the worth of a company in terms of it’s shares! To put it in a simple way, if you were to buy all the shares of a particular company, what is the amount you would have to pay? That amount is called the “market capitalization”!
To calculate the market cap of a particular company, simply multiply the “current share price” by the “number of shares issued by the company”! Just to give you an idea, Tata Motor, has market cap of Rs-49,544.58 Cr. (as on 01/10/11)
Depending on the value of the market cap, the company will either be a “mid-cap” or “large-cap” or “small-cap” company!
Now to know the Market Cap we dont have to do any calculation most of the sites provide that details directly. For example if you visit the following sites.
http://money.rediff.com/
http://www.moneycontrol.com/
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Are Stock Splits Good for Investors
Stock splits may seem like a gift to some investors, but there is little evidence that you benefit in any meaningful way when a company splits its stock.
Here’s what happens. Tata Motors, which is currently priced at Rs 800 per share, announces a 5-for-1 stock split. If you own 100 shares before the split worth Rs 8,000, you will own 500 shares worth Rs 8,000 after the split. (it recently happened with me and you can not believe next day i was worried how come this stock falled down 80% (i was not aware of the split) when search for news that time came to know 5-for-1 stock split...so bad of me not reading the news about the
company.)
The market automatically marks down the price of the stock by the divisor of the split. The Rs 800 per share price becomes Rs 160 per share.
There are other splits such as 3-for-1 and 3-for-2, however 2-for-1 seems the most common.
It terms of what your holdings are worth, nothing changes. In terms of what the company is worth, nothing changes. So, why do it?
Why Split?
Perception – Some companies worry when the per share price gets too high that it will scare off some investors, especially small investors. Splitting the stock brings the per share price down to a reasonable level.
Liquidity – If a stock’s price rises into the hundreds of dollars per share, it may reduce the trading volume. Increasing the number of outstanding shares at a lower per share price aids liquidity.
Is it Good for Investors?
Some investors say a stock split is a sign that a stock is doing well and they consider it a buy signal. I would caution reading too much into a stock split by itself. You should always look at the whole picture before making an investment decision. If you want to use stock splits as a marker for stocks to consider for further evaluation, that is a reasonable idea, but don’t stop there with your research.
Caution
You should watch out for one type of split as a possible danger signal and that’s the reverse split. In a reverse split, the company reduces the number of outstanding shares and the per share price rises accordingly.
For example, a company might execute a 1-for-2 reverse stock split, which means for every two shares you own, you would now own one and the per share price doubles.
A reverse stock split is often used to prop up a stock’s price, since the price rises on the split. Often a company will do a reverse split to keep the stock price from falling below the minimum required by the stock exchange where it is listed.
Clearly, this is a sign that something is wrong if a company can’t keep its stock price above the exchange’s minimum listing price and caution is advised.
When you paid stockbrokers based on the number of shares you purchased, it made sense to buy a stock before it split. However, most brokers now charge a flat fee, so timing a purchase before or after a split doesn’t make much sense from that perspective.
Ultimately, you should buy a stock based on whether it meets the fundamental standards you require and not on whether it will or will not split.
Here’s what happens. Tata Motors, which is currently priced at Rs 800 per share, announces a 5-for-1 stock split. If you own 100 shares before the split worth Rs 8,000, you will own 500 shares worth Rs 8,000 after the split. (it recently happened with me and you can not believe next day i was worried how come this stock falled down 80% (i was not aware of the split) when search for news that time came to know 5-for-1 stock split...so bad of me not reading the news about thecompany.)
The market automatically marks down the price of the stock by the divisor of the split. The Rs 800 per share price becomes Rs 160 per share.
There are other splits such as 3-for-1 and 3-for-2, however 2-for-1 seems the most common.
It terms of what your holdings are worth, nothing changes. In terms of what the company is worth, nothing changes. So, why do it?
Why Split?
Perception – Some companies worry when the per share price gets too high that it will scare off some investors, especially small investors. Splitting the stock brings the per share price down to a reasonable level.
Liquidity – If a stock’s price rises into the hundreds of dollars per share, it may reduce the trading volume. Increasing the number of outstanding shares at a lower per share price aids liquidity.
Is it Good for Investors?
Some investors say a stock split is a sign that a stock is doing well and they consider it a buy signal. I would caution reading too much into a stock split by itself. You should always look at the whole picture before making an investment decision. If you want to use stock splits as a marker for stocks to consider for further evaluation, that is a reasonable idea, but don’t stop there with your research.
Caution
You should watch out for one type of split as a possible danger signal and that’s the reverse split. In a reverse split, the company reduces the number of outstanding shares and the per share price rises accordingly.
For example, a company might execute a 1-for-2 reverse stock split, which means for every two shares you own, you would now own one and the per share price doubles.
A reverse stock split is often used to prop up a stock’s price, since the price rises on the split. Often a company will do a reverse split to keep the stock price from falling below the minimum required by the stock exchange where it is listed.
Clearly, this is a sign that something is wrong if a company can’t keep its stock price above the exchange’s minimum listing price and caution is advised.
When you paid stockbrokers based on the number of shares you purchased, it made sense to buy a stock before it split. However, most brokers now charge a flat fee, so timing a purchase before or after a split doesn’t make much sense from that perspective.
Ultimately, you should buy a stock based on whether it meets the fundamental standards you require and not on whether it will or will not split.
How to decide the price of a stock
Knowing how to value a stock is extremely important before you take a buy call and invest your money.
Methods of Deciding Stock Valuation
Analyze Financial Results :-
Analyzing financial results carefully, is one of the best methods to decide the right valuation for a stock. The company which posts healthy sales turnover and net profit can get a better valuation than its peers struggling to maintain their margins. This method of how to value a stock will give you profit at most times. Only in times of sudden stock market falls or heavy corrections can you go wrong with this method of stock valuation.
Look at the Earnings Per Share (EPS) :-
A method of how to value a stock is to look at the earnings per share ratio (EPS) of the stock. Companies which post high EPS are generally the market favorites, and will give decent return in the time to come. Low earnings per share can mean problems for the company on the execution front, because of which the net profits are under pressure. Reputed companies generally have good earnings per share ratio due to which such stocks are highly recommended.
Sales and Profit Growth :-
Another answer of how to value a stock is by observing the sales and profit growth of the company of the past few years. If you observe that the sales and profits are growing at a rapid pace, more than that of the entire industry, then you might consider taking some positions in the stock, even though the current earnings are not that well. It is important to consider the net profit, and not the gross profit, while you calculate the profitability of companies.
Watch for Debt Component :-
One thing you should always keep in mind is that investment should be done in debt free and high cash generating companies rather than those ridden in debt. The debt to equity ratio of a company should be comfortable, if you wish to buy stock of companies which have taken debt for fast expansion. What happens is that when the debt is too high, most of the income of the company is spent in repaying creditors, which leaves a very low net profit.
Market Capitalization :-
Another way to know how to value a stock is by observing its market capitalization growth. Stocks with high market capitalization should have equally strong earnings. In case the earnings are not at par with the current market capitalization enjoyed by the company, then the chances of the stock price falling down are more. Many experts suggest buying into mid cap and small cap stocks which are low priced and have a good growth potential.
By following these methods of how to value a stock, you will be able to buy stocks that are promising and thereby, earn cool returns through stock price appreciation, as well as dividends. So, think over it and act smartly. Good luck!
