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    What are the Major Differences Between Hedging & Speculation?

    Published on October 5, 2021

    Hedging and speculation are the prominent terms that you would usually hear with futures trading. Most people, including trade, typically use the term to deliver the same thing or when talking about the price movement. The two terms allude to absolutely different things. The significant difference between the two is that hedging mentions reducing risk, while the purpose of speculation is to make a profit. To clearly understand these vital concepts of future tradingand their usage, you must know the differences between Hedging and Speculation.

    What is Hedging?

    Hedging is a common strategy to reduce price risk in terms of adverse movement. Or you can say that it helps investors to minimise or even eliminate the chances of loss due to a massive movement in the underlying asset’s price. To implement hedging, a skilled trader must take opposite positions in two separate markets. In such a way, a loss in one market could be offset by the gain in another market.

    What is Speculation?

    Speculation is generally purchasing and selling assets with expectations of making a profit from the change in the price. Hence, speculators or traders here enter into trading by recognising opportunities to attain monetary advantages from the fluctuations in the rate of underlying assets. Thus, the underlying asset could be bonds, stocks, currencies, derivatives, and more.

    Mostly, speculators incorporate their expertise and several methodologies (fundamental and technical analysis) to get calculated guesses or evaluate the underlying asset’s price movement.

    Hedging vs Speculation – Differences

    Check out the following major differences between Hedging and Speculation:

    Meaning

    Hedging is simply a strategy to protect an investment from future adverse rate movement.

    Whereas, speculation is a strategy used to make a profit by trading in a risky asset.

    Purpose

    The primary purpose of hedging is to reduce or get away with the risk.

    The sole purpose of speculation is to gain a profit by taking a little risk.

    Involves

    Hedging involves protection from the future movement in price.

    In contrast, speculation involves using price movements to make some profit.

    Operators

    Generally, a risk-averse investor prefers hedging.

    On the contrary, some investors who enjoy taking a risk to gain a profit choose speculation.

    Risk Management

    Hedges employ hedging to handle their risk.

    Whereas, speculators employ other methods to handle risks like limit orders and stop-loss.

    Volatility

    Hedgers aim to protect themselves from price volatility.

    On the other hand, speculators utilise price volatility to earn a profit.

    Profit Potential

    In hedging, there is no profit potential as the purpose is to reduce the risk of future and option trading.

    However, there is enormous profit potential in speculation. That’s what motivates investors to take a risk.

    Hedging vs Speculation – Which is Better?

    Hedging can be referred to as a kind of insurance. You don’t buy it to earn a profit, instead of as protection from unpredicted losses. Although a hedger pays the cost of the contract, in the long term, it helps in stabilising the profit margin. However, speculation may seem like a kind of gambling, but it ultimately helps boost the markets in the long run.

    Hence, both hedging and speculation are widespread practices of the financial and business markets globally. One helps to protect an investment, while the other helps to earn a profit. Although, hedging is not just preferred by traders, but by businesses too. On the other hand, speculation is common among traders. However, an investor should make the most out of both strategies to protect their portfolio and gain profit by taking a calculated risk.