Speculation vs. Hedging

Written by JS T Alexander | 08 August 2010

The Art of Trading

Speculation as defined is simply to gain from price fluctuations without the intention of owning the particular instrument and in the process of doing so is willing to take the risk of loss if the price moves in the opposite direction in exchange for a potential profit while trading the market.

Interbank transactions are done considerably and used as guiding rates for others to level their bid/ask prices. The basis of speculation could be on different situations like most often traders would anticipate what numbers would come out on an economic news, where prices move as a result of the report, estimates, profit earnings target, sales and revenue figures broken down to certain periods are just some of what traders do speculate on. And the bottom line is to be able to gain from all these numbers associated in business. And along this line is the act of forecasting which are often based on technical mathematical designs that helps measure relatively the strength and weaknesses of the market. It has become a science where theoretical numbers are calculated to show how prices are speculated on before and after the markets moved. Although speculation could either be on a fundamental basis which could also mean economic and political. As we have mentioned, on a technical perspective.

The Strategy

All these combined together supports the Strategy on how to manage the market. Having a strategy composed of related positions as precautionary trade measures would be appropriate. These would become layers of cushion, so to speak which in most times is called “hedging”.

As a result of these strategies in place, it is safeguarding valuable assets either in revenue earnings or foreign exchange value (physicals) from deteriorating in value. Companies who have international business exposure in different countries run the risk of economic and political factors that may affect their bottom line figures. However, as the world becomes more global the entire business defines no more borders as most basic products are related with each other. It is the other side of the domino effect which is something that everyone should contemplate on.

But how to integrate hedging technique with speculation or vice-versa has to meet certain criteria. In some cases like the other markets where most traders/investors use spreads, straddles and strangles just to name a few. Sometimes just to show that there could be good opportunities in both the up and down of the market direction. Which is actually true, given the fact that “short selling” is another technique that traders apply in their stocks, commodity futures and also in the options market.

So the total number of applications and strategies are wide as it really boils down to the final decision that investors would use in the trading. Experience and trading maturity will be the primary guide in what best suits the trade. The level of comfort even in adverse situations is the gauge of being in control regardless where the price takes the trade to overall net positioning will and can level the markets’ playing field. However, timing is quite essential because if there is no need to do such precautionary measures then what comes next should already be in place to maximize price movements. Position averaging increase leverage and exposure must always be calculated at worst conditions along live market quotes. Position track is one that would support this strategy and it can show the overall performance of all spread positions in the actual/ or real time market place. In short, providing a birds’ eye view or summary of the investment is important.