What is hedging?
Hedging means taking a position against the physical market to reduce or limit risks associated with unpredicted movement in price. As you know that nobody can predict about future in the market. So a trader who is trading in spot market won’t take risk. They do hedge against their position with derivatives. Derivatives can be options, swaps, futures and forward contracts.
Which type of trader hedge their positions?
Retail investors, portfolio managers, corporations, farmer as well as govt. fund housing use hedging to reduce their risk exposure.
How does it work with commodity market?
As we know the commodity market is highly volatile market. If a trader want to protect themselves from the risk of fluctuations they trade against the position in future market.
Let me explain with example:
If a farmer expecting that the price of Chana might fall in coming days from 80/kg to 70/kg, in that case he will sell a future contracts at today's price (i.e. Rs 80/kg). Now he is safe, even if the price will falls to 70/kg, he will still get Rs 80/kg according to the contract. By this selling position in the future market in order to protect one's investments against downside risk is called short hedging.
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