Recently, the futures investment market has become immense. You may be asking yourself “What has lead to this massive growth in futures trading? Well, One obvious answer is Leverage. Unlike equities, futures give you the opportunity to trade with leverage, dramatically increasing profit  and loss potential. As we will discuss, there are two main strategies which account for these yields, helping futures traders profit worldwide. These are “speculation” and “hedging”.

By definition, “speculating” is purchasing a naked futures position , hoping the market will go in the direction you predict. For example, a futures trader would be speculating if they bought “long” crude oil futures at $72, hoping to cash out at some point above that price. As you can see, a speculator would earn money if they choose the right direction of the market, using either a buy (“long“) or sell (“short“) position to profit. Typically, speculators are stuck to their computer screens analyzing the futures markets, waiting for the latest price break or news release. Once it happens, the trader jumps on the opportunity, positioning themselves accordingly. Even though the high returns may sound great, the fact is, there can also be higher risk. With even the best traders in the world, the leverage in futures make speculation a double-edged sword.

In contrast to speculation, “hedging” is defining your risk by protecting your investment on both sides of the market. Though this may sound confusing, it is far safer AND easier than speculation. For example, a futures trader may buy 10 “long” crude oil positions at $72, and if the market looked like it was declining below $72, they would buy 10 put options to “cover” their 10 “long” crude oil positions. By doing this, they offset positions and are no longer responsible for any losses below the “strike price” of options, their lose is defined to the cost of the option. Typically, a smart hedger covers their open positions as soon as the markets show any sign of risk.  Even though hedging can hurt overall yields, it keeps the accounts protected from volatility. Generally, futures hedgers have a strategy which is focused on risk prevention first, using spreads and options to earn their profits.

Though most futures traders are either speculators or hedgers, there are times when both strategies should be used. For example, a savvy hedger could use “long” futures positions to take advantage of a market swing in Gold.  In contrast,a smart speculator could hedge during high risk and volatility, buying options or futures to cover “short” positions in crude oil.  It is Global Leverage’s opinion that hedging and speculation are best used together. In fact, each strategy has distinct flaws which prohibit it from succeeding alone in the futures market.

As you can see, futures trading can be very complicated. If you’re a smart futures trader, you should always have a hedging strategy in place during volatile markets. Though some traders choose to speculate for higher returns, many also invest in managed futures, benefiting from speculation only during the biggest market swings.   Remember, each futures trader does have their own unique strategy, but risk should always be the main focus, not just high returns.

In summary, hedging and speculating are the main strategies utilized by futures traders. Speculation focuses on earning high returns by predicting price movement, while hedging focuses on minimizing risk and stabilizing returns.  Though either strategy can generate profit, it’s always a good idea to use both when trading futures. Whether you choose to speculate or hedge, the reality is, futures trading is only as risky as the strategy.