Back To The Futures

Either a Hedger or a Speculator Be

Futures market participants fall into two categories: hedgers and speculators. Futures markets exist primarily for hedging, or the management of the risks inherent in the ownership of commodities. Hedgers may invest in the futures market for many reasons, including to protect their inventory from price fluctuations or to cover a carrying charge for inventories held.

Hedgers reason that a loss in one market could mean a profit in another. A farmer with a silo full of newly harvested corn, for example, would be considered "long" on the cash commodity, and he or she might take a futures position against future declines in the price of corn. In agricultural commodities, other hedgers include exporters, importers and processors.

Those who hold investments that mirror a specific index might want to hedge against the possibility that the stock market may fall by selling a contract on that index in the futures market. If your company does a great deal of business abroad, you might want to use the futures markets to hedge the fluctuation of the currencies of the countries with which you trade.

If the only people who traded futures were hedgers, the markets would be much smaller and less accessible--which brings us to the other type of futures animal: the speculator. Speculators are attracted to futures markets by the potential to make a profit if they can correctly predict the direction of prices on an underlying commodity. They provide liquidity in futures markets, but speculation is just that: taking a high-risk position with the express intent of making a profit.

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This article was originally published in the August 1998 print edition of Entrepreneur with the headline: Back To The Futures.

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