In other words, hedging means that traders trade the same commodity in the spot market and the futures market at the same time or later with the same quantity and opposite directions (which means that the futures market trades later in the spot market)-that is, they buy (or sell) a commodity in the spot market at the same time or later, and sell (or buy) futures contracts of the same variety, the same quantity and opposite directions in the futures market, so as to buy (or sell) in the future.
Traders can also substitute (or hedge) future physical transactions through futures trading. I want to buy physical objects in the spot market in the future, and now I want to buy futures contracts in the futures market. Its basic feature is that the second trading position in the futures market is opposite to the trading direction in the spot market.
The main purpose of hedging is to minimize the risks caused by price fluctuations. It is an effective means to achieve this goal, enabling traders in the futures market to avoid (or transfer) price risks, prevent (or mitigate) losses, and reduce the current (or potential) price risks of spot positions.
In fact, the fundamental reason why the futures market exists is that it provides a place for hedgers to transfer price risks. One of the main economic functions of the futures market is to have a price risk transfer mechanism. The existence of this mechanism enables traders in the futures market to avoid or transfer price risks and prevent or mitigate losses. And the means to achieve this goal is hedging. The function of hedging can be summarized as the following aspects.
1. can stabilize the product cost.
Hedging can make enterprises avoid the adverse effects of price fluctuations on their operations to a great extent, thus "locking in costs", enabling enterprises to control costs according to operating arrangements, stabilize production and business activities, and thus play a positive role in the stability of social costs.
2. Save social capital
Hedging transaction can realize the purchase and sale of goods with several times or 10 times the margin with a small amount of margin, so that economic entities can frequently enter the market with less funds, so that the funds of economic entities can get rid of the situation that they are occupied by a large amount of inventory, and save the corresponding storage costs and reduce operating costs. This has accelerated the circulation of social capital and saved social capital to a certain extent.
3. Enhance the liquidity of futures trading.
A dynamic futures contract is always accompanied by a lot of hedging activities, otherwise it will be difficult to exist. Although speculative activities can generate short-term trading volume, most speculative activities are unstable and uncertain, and many speculative yellow holdings often last only a few weeks. The liquidity provided by market makers in the futures trading hall is also very limited, usually only within one day. If there are no speculators and hedgers in one trading pool, market makers will leave quickly and go to another trading pool. Therefore, hedgers are the supporters and main force of the futures market. Hedgers greatly enhance the liquidity of futures trading through hedging transactions.
4. Form a reasonable price level
Hedging itself has the function of stabilizing commodity prices. When commodity prices are low, hedgers compete to buy contracts in the market, which can make commodity prices rebound; When commodity prices are high, hedgers compete to sell contracts, which makes commodity prices fall back. Through the chain reaction with the whole commodity market, the price of the whole market tends to be stable, thus forming a reasonable price level.