Hey, so what the heck is this hedging? It’s quite a new term for the beginners in forex trading, but no worries. Maybe this article should help you explore about hedging and speculating. Actually, hedging refers to locking in a future price for the commodity in order to minimize risk it’s a form of diversification. Hedging involves taking an offsetting position in a derivative in order to balance any gains and losses to the underlying asset. It attempts to eliminate the volatility associated with the price of an asset by taking offsetting positions contrary to what the investor currently has. On the other side, speculations means agreeing to a futures contract in order to profit by taking risks. Its main function is to profit from betting on the direction in which an asset will be moving. Speculation in stocks, currencies and commodities and futures is a necessary part of our economy. Speculation in another word means risk taking. The benefits of speculating are plentiful but if only played safe. It’s a matter of high risk.
Why is hedging useful?
Hedging has its own importance. If you want to make money investing in stocks, then you should know about risk hedging. Traders use hedging in order to counterbalance the influence of currency pair fluctuations. As for example, if a business operating overseas wanted t knows exactly how much revenue it will obtain (i.e. in U.S dollars from its European stores, it could purchase a futures contract in the amount of its projected net sales to eliminate currency fluctuations. One major reason why companies attempt to hedge these price changes is because they are risks that are peripheral to the central business in which they operate. For example, an investor buys the stock of a pulp-and-paper company in order to gain from its management of a pulp-and-paper business. He/she does not buy the stock in order to take advantage of a falling Canadian dollar, knowing that the company exports over 75% of its product to overseas markets. This is the insurance argument in favor of hedging. Similarly, companies are expected to take out insurance against their exposure to the effects of theft or fire. Hedging the exposure of the firm to its financial price risk helps improve or maintain the competitiveness of the firm.
How are hedging and speculation related or what are the differences between hedging and speculation?
When talking about hedging, it’s different from speculation on the basis of following points:-
>> Hedging is used to reduce risk and manage margins.
>> It helps to reduce the fluctuations in propane prices for retailers and end users.
>> Hedging is used to “back to back” sales to residential/commercial customers at a fixed profit margin.
>> Hedging plays an important role in managing and growing your retail propane company.
These are the features that separate hedging from speculation. So what are the features of speculation? The features of speculation can be listed here:-
>> When it comes to speculation, “betting” the market will move in one direction.
>> Retailers buy product on a fixed price but charge market-based prices to their consumers
>> Speculation creates chances of increased risk and uncertainty on retail margins.
>> Speculation can literally put you out of business.
And now perhaps you are clear to some extent about hedging and speculating, let’s hope so!