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Hedging, Speculating, Investing… What’s the Difference?

Hedging, Speculating, Investing… What’s the Difference?
June 07
00:30 2012

What is investing?

Investing is the act of putting your money or capital in the market with the expectation that it will gain a return. The most widely practiced form of this is retirement investing where individuals set aside a certain portion of their income and select different investment vehicles to put their money to work. These investment vehicles can include equity, debt or alternative vehicles such as currencies, options, or futures. Earnings from these investments are often reinvested and can grow exponentially over the years due to the principle of compounding interest. These investments must be managed, either by individuals or institutions, with the purpose of not only protecting the principal investment but to also get a return on investment. However, investors face the possibility of both gains and losses.

What is speculating?

Speculation is the practice of risking capital in selective investment vehicles for the purpose of making profit off of anticipated movements in the price of a financial instrument. Financial instruments such as futures contracts are considered speculative by nature because there is no intent to purchase the underlying asset.

Speculation includes buying, holding, and selling financial instruments. Speculation also includes short selling, which is the practice of borrowing ownership of a financial instrument from a broker at the current price in order to sell at a lower price.

The idea behind speculation is to make profit quickly. Like investors, speculators are exposed to both gains and losses in their trading experience. However, unlike investors, speculators are holding positions for a much shorter time period ranging from months to minutes.

What is hedging?

Hedging is a type of risk management strategy to protect against adverse price movements. Hedging a position is a method of offsetting risk by investing in a related security or a derivative of the security including options or futures. Here is an example of hedging. If a commercial farmer wishes to sell corn on the open market he can hedge against the risk of fluctuations in weather or market conditions by investing in corn futures contracts. Hedging is practiced by companies, investors and speculators.

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