Learn Futures Trading | Hedging Futures

Many investors will use futures hedging as a risk management tool when they are investing in many market areas. Hedging is the act of placing short-term positions within the futures market, that are equally the same amount but they are on the opposite side of their cash investments. Meaning that if an investor is taking long positions within one market, they will take short positions in the futures market. The hopes of this are that if one side is being hit with unfavourable price movements, the other is gaining, thus avoiding total loss, and instead balancing out.

Often this method of risk management is employed by professionals, large companies or corporations, as well as from market makers or brokerage firms. The commodity prices are generally decided on by the speculators and the hedgers. A speculator is the one whom will take on the risk with the objective of profiting by way of speculating the price movements of the futures options. A hedger is only using the futures to aide in risk management when and if the market movements are not in their favor.

Many seasoned investors will use something known as the neutral approach. This in simple terms means that the investor will invest the same amount in pounds / dollars in shares as they do in the futures. Meaning if they have 50000 GBP invested in ABC Technology shares they will take 50000 GBP and short it into FTSE (or the equivalent exchange sector).

There are numerous variations and strategies involved in hedging such as but not limited to the following: use of future contracts using interest, future contracts by means of currency, money market using interest or currencies as well as foreign exchange contracts for interest or currencies.

The hedger by far as better chances of producing positive gains as they are not taking on as much risk as the speculator. As one can imagine, the speculator is taking on much higher risk as there are many risk factors that must be taken into account. Even so, if the market movements are in their favor and they have appropriately applied the correct options they can make substantial profits.

If hedging does not make sense to you, and it seems much too confusing as to the concept think of it this way; as one professor once told his students whom did not understand the strategy behind hedging futures – if you were at the the World Cup and you were unsure which team would win, you would place the same bet on both teams. You would not gain, but you would not suffer loss.