What is the difference between a commodities Speculator and a Hedger?

Am I a speculator or a hedger?

There are two types of traders in commodities – Speculators and Hedgers.

You, more than likely, are a speculator. Speculators are the vast majority of people who are buying and selling contracts in order to profit from predictions in the way the market moves. A speculator is not involved with the actual production of the commodity or in the selling of the physical good; usually they do not want to take delivery of the huge amounts of the commodity. They are only interested in holding contracts of the commodity to later sell at a better price.

Who are these people that are speculators? It’s people like you and me! Teachers, engineers, salespeople, secretaries, mechanics, lawyers, stay-at-home moms and dads. It can be anybody!

A hedger, on the other hand, usually has his hand in another side of the business. Perhaps he is a farmer, or a dealer of the commodity being sold. To “hedge” is to protect oneself from an adverse move against the business.

For example, the corn farmer wants the price of corn to go up so he can make more money on the product he grew. However, in the chance that it goes down, the farmer can purchase contracts of future corn betting that it will go down. This way, regardless of the actual move in the price of corn, the farmer can be in a win-win situation.

In other arenas, such as sports, this would be highly frowned upon. In fact as a player, putting money on the line to make any sort of prediction will get you banned – just ask Pete Rose. But in the commodities world, this is a perfectly legitimate way to let farmers protect themselves. Unlike sports, there’s no conflict of interest in the outcome. The farmer is going to produce as much as he can regardless of which direction the market moves.