Hedger vs Speculator

October 11, 2016 4:02AM CDT

My previous article explained who hedges, and what that means. US merchants needed to ensure there were buyers and sellers for their products (commodities). The result was a forward contract to buy and sell commodities (futures). The days of farmers bringing samples of their crops for inspection to the trading floor have evolved into an arena that sets future prices with the aid of the speculative investor. Hedgers trade to secure the future price of the commodity (or financial instrument) of which they will take delivery, and later sell in the cash market. They need to protect themselves against future price risk.

Then there are the investors who speculate on the price change potential. A speculator makes risky investments, anticipating a major change in the future price and trades solely for profit.  Financial speculation involves the buying, holding, and selling to profit from fluctuations in its price as opposed to buying it for use.

The interaction between speculators and hedgers is what makes the futures markets efficient.  A hedger may try to take the speculator’s money and vice versa.  How?

A speculator may buy a contract at low price anticipating that it will be worth more closer to expiration.  The hedger sells at that same low price because he expects the price to decline further, therefore protecting his product from lower cash prices. Speculators assume price variability, which makes the transfer possible in exchange for the potential to gain.  Thus, a hedger and a speculator can both be very happy from the outcome of price variability in the same market.

Together they provide the volume and the volatility that necessary to set future prices and protection.

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