Hedging – What Is It, And It's Uses In Risk Management
Second of a two part article
Before I discuss the use of hedging to off-set risk, we need to understand the role and the purpose of hedging. The history of modern futures trading began in Chicago in the early 1800's. Chicago is located at the base of the Great Lakes, close to the farmlands and cattle country of the U.S. Midwest making it a natural center for transportation, distribution and trading of agricultural produce. Gluts and shortages of these products caused chaotic fluctuations in price. This led to the development of a market enabling grain merchants, processors. Agriculture companies to trade in contracts to insulate them from the risk of adverse price change and enable them to hedge.
Commodity trading is made up of dissimilar areas such as energies, currencies stock indices, , bonds among others. These are the issues that assist you in attaining additional income. As a Forex dealer, you require to give the impression of looking for the best commodities obtainable readily available to assist you to gross earnings potentials. In article of trade trading, the primary thing that you need to do is to look at the chart of any type of commodity.
Here you will see the trends that you can buy and sell for a good profit. To be proficient to do this, you require making employ of a technological trading system and looking at the trend in longer provisions earlier than you trend. The second thing you need to think about is taking note of some of the best Forex markets out there so that you can bring your commodities to bear in an environment where maximum profit can be made.
While most of the trends online and offline in markets all over the world give really good rates, there are often others that give even better ones that you may not know about if you do not bother to find out about them. Finding this great deals that are rock solid and consistent is the key to getting lightning quick trading dollars into your bank account. The third thing you need to think about of course, is how best to diversify your commodity in the market. Here, sitting on your eggs without allowing them to hatch will only limit how much money you will make in the end of the day and you need to be braver with your portfolio and make some risks by putting your commodities out there.
This is the key to really making some good money...
The first commodity exchange was the creation of the Chicago Board of Trade, CBOT in 1848. Since then, modern derivative products have grown to include more than the agricultural industry. Products include Stock Indices, Interest Rates, Currency, Precious Metals, Oil and Gas, Steel and a host of others. The origins of the commodity and futures exchange was created to support hedging. The role of speculators is beneficial as they add trading volume and important volatility to what'd otherwise be a small and illiquid market place.
A bona-fide hedger is someone with an actual product to buy or sell. The hedger establishes an off-setting position on the futures or commodity exchange, thereby instituting a set price for his product. Someone buying a hedge is known as being “Long”. “Taking Delivery”. Someone selling a hedge is known as being “Short”. “Making Delivery”. These positions known as “Contracts”. Are legally binding and enforced by the exchange.
Entering your trades either for speculation or hedging is done through your broker or Commodity Trading Advisor. Commodity and Futures exchanges are distinct from Stock Exchanges, although they operate using the same principals. They're regulated by different agencies such as the Commodity Futures Trading Commission who are responsible for regulation of retail brokers in the USA as well as Commodity Trading Advisors who are really Portfolio Managers for derivatives.
Now let's view some real life examples of hedging or mitigation of risk by using exchange traded derivatives.
Example 1: A mutual fund manager has a portfolio valued at $10 million closely resembling the S&P 500 index. The Portfolio Manager believes the economy is worsening with deteriorating corporate returns. The next two to three weeks are reports of quarterly corporate earnings. Until the report exposes which companies have poor earnings, he's concerned of the results from a short term general market correction. Without the privilege of foresight, he's unsure of the magnitude the earnings figures will produce. He now has an exposure to Market Risk.