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Differentiate between hedging and speculation
Hedging and speculators play an important role in markets. Hedgers protect themselves against reduced risk of commodities by hedging and by speculation speculators earn profits from changes.
Hedging
The term hedging is used to minimize risk of loss due to price movement in the market.This is done by holding two different positions in different markets. In most cases, Loss or gain in one market offset price movements in another market.
Some of the advantages are increases liquidity, lowers margin, can invest in various assets, offers flexible price mechanism.
Hedging strategies − Forward contract, future contract and money markets.
Investors hedge by asset allocation, structure and through options.
Examples of hedging are diversification, arbitrage, average down, staying in cash, etc.
Speculation
The term speculation is used to buy or sell an asset, hoping for good returns in future price change. Stocks, currencies, bonds etc. are some of the opportunities for speculators to take advantage of price changes in financial assets.
They analysed and calculated the risk before investing. Investors who do speculation make decisions based on technical analysis rather than fundamental analysis which mean they concern more about stock trading profit than company performance.
Some of the advantages of speculations are economic welfare, market liquidity and risk bearing. Some of the disadvantages of speculations are prices are unreasonable, economic bubbles.
Bullish and bearish speculators are types of speculators
Speculation in currency market: Foreign currency exchange will have more fluctuations between currencies. This market also provides an opportunity to earn profits for investors because many currencies are involved.
Speculation in commodity market: Without speculation commodity market will have very limited players. Speculations add liquidity to the market and also help market participants to trade. Speculations also have impact on Price of commodities and shortages will be prevented
Speculations in stock market− high risk offers high returns. Speculators play an important role in public traded companies by investing and also help in grow and expand
Differences
The major differences between hedging and speculation are as follows −
| Sr.No | Hedging | Speculation |
|---|---|---|
| 1 | Prevents an act of investment from an unexpected price change. | Investors trade financial assets having significant risk and hoping to get profits. |
| 2 | It controls price risk. | Relies on risk factor. |
| 3 | Involves protection against price changes. | Involves incurring risk in order to make profits. |
| 4 | Operators are the ones who are unwilling to take risks. | Operators are those who are willing to take risks. |
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