This week, we’re diving into hedging, a strategy used to protect against risks, unlike speculation, which aims to profit from price movements. We will break it down with an example of an aluminium producer.

Speculation vs. Hedging

Speculation: A trader starts without a position, choosing to go long (buy) expecting prices to rise or short (sell) expecting prices to fall.

Hedging: Instead of predicting prices, hedging protects against risks like falling prices.

Aluminium producer’s risk

An aluminium producer faces a major risk if market prices drop. Ideally, the producer could fix a sales price to avoid losses, but long-term price guarantees are rare due to market volatility.

What is volatility?

Volatility refers to price fluctuations around an average value. It can occur within:

Stable markets: Prices move up and down around a median price.
Trending markets: Prices fluctuate within an upward or downward trend.

Why hedge?

For an aluminium producer, falling prices can threaten profitability, making it harder to cover production costs and overheads. Hedging helps mitigate this risk by protecting against price declines.

Stay tuned as we explore how hedging works in the aluminium market next time!