Once you have selected a broker and completed all the paperwork, the next step is to deposit the margin required for commodity trading. There are two types of margins in commodity trading: initial margin and maintenance margin.
Initial margin in commodity trading
Initial margin is the amount that you have to deposit with your broker before you can start trading in commodities. The amount of initial margin depends on the commodity you want to trade in and the exchange that you will be trading on. In most cases, however, the initial margin requirement is 5–10% of the contract value.
Let us say you are trading in a commodity futures contract worth Rs 10,000. The margin requirement for the commodity you are trading in is 5% on your exchange. In this case, you need to deposit a margin of Rs 500 (i.e. 5% of Rs.10,000) before you can start trading.
The margin requirements ensure that your account always has enough money to settle the trade if you make a loss. If you incur a loss while trading in stocks, your shares simply fall in value. They may fetch less value when you sell them, compared to the rate at which you bought them. But you do not have to pay anything to your broker.
In commodities trading, your position is marked to market every day. This is when your Margin account is adjusted to take into account the day's market change. Whatever profit or loss you make is adjusted to your account. If you make a loss, your account balance reduces by the amount of the loss. This is why you need to start with some balance in your account. The initial margin allows your broker to debit your loss instantly from your trading account.
Maintenance margin in commodity trading
As your losses mount, the balance in your trading account falls. If this balance falls to a predefined threshold, the broker may ask you to top it up. The predefined threshold is called the maintenance margin. The money you have to bring to replenish your account is called margin money.
When you make a profit in trading, your account balance rises above the margin requirement. You can withdraw the excess amount in your account, if you like.
Continuing with the earlier example, let us say your exchange requires a maintenance margin of 3% for the commodity in which you are trading. In this case, you have to maintain a minimum account balance of Rs 300 (i.e. 3% of Rs 10,000) at all times.
Now, suppose you constantly lose money on your investment and your account balance falls to Rs 280. Since this is below the maintenance margin of Rs 300, your broker may make a margin call to you. You will have to deposit money to replenish your margin.
In the next chapter, we will look at the third important step for trading in commodity futures in India: accessing information and devising a trading plan.