Hedging and Speculating

[Arthur 10]

I am unaware about the concept of hedging and speculation. What are the importance of using this and how can hedging and speculation help in avoiding loss while trading ?

Regards

aurthur

[TheNegotiator 13]

One way people use it in derivatives is to take another position in another product which is correlated. For example, you might believe stocks are trending higher but that techs may outpace overall. So, you could decide to take a long(buy) postion in say the Nasdaq future and a short(sell) position in say the Dow mini future. This way, as they go up, you will probably get a smaller profit overall, but any move against you will also be controlled by the short position in the, what you presume to be, weaker Dow. Options are very much about hedging strategies. I am no expert on this so either let an options member weigh in or you could pop over to our options section of the forums and ask there.

[Davisjjr 10]

hi Arthur, I am just a newbie too, I'm currently studying how the trading system works and I've just read a topic about hedging and speculating, here's how I understand those terms:

 

A hedger is a kind of trader that tries to guard against price changes. Hedging is a method on which they trade to have some sort of insurance when the market's on a turmoil. For example, a clothing company may hedge against the risks in an increase in the price of cotton and fabric so they will buy futures contracts on those materials. So if the price of those materials go up the profit will help the company maintain the funding for the increased price of its raw materials.

 

speculating is a way to gain profit from the price changes in the market.

 

The major difference between hedging and speculating is that in hedging the primary goal is not to profit but to insure a company from price changes, in speculating the goal is to profit from price changes.

 

Hope this helps.

[philmg 10]

Well, I also have some trouble seeing the point of hedging for trader. Maybe someone can elaborate a bit more. I get the point of protecting oneself from downside risk, but how I see it it also protects against profit potential.

 

If you take the example from the first post:

If you expect tech to go up and you take a short in ES futures to hedge, then you basically dramatically reduce your profit potential and concurrently your market risk. Why would you do that. In case of trading you try to make money by exploiting the swings.

 

I don' t see the point, maybe I am missing something. How do hedge funds make so much money with hedging or do they not actually hedge?

 

Would be geat if someone of the experienced guys could give some more insight. thanks!