Hedging — The ‘Key’ Between Spot and Futures Market
Suppose you have a significant portion of your holdings in GFJ (grapefruit juice) coin, the hottest new hypothetical cryptocurrency. But through a reliable hypothetical source, you discover that the value of GFJ could be halved. So, how do you protect yourself?
Market price fluctuations occur unexpectedly. Sudden price fluctuations can be a huge benefit for some, but a big loss for others. Moreover, in the spot market, it is difficult for a person who owns a product to profit when the price falls.
But what happens if you trade in both spots and futures markets at the same time? The futures market can generate profits in both directions, whether the price goes down or goes up. You can choose the long position when you think the price go up, or the short position when you think the price will go down. The price of the GFJ coin is likely to fall, so let’s place an order for short position. If your choice is right and the price of GFJ coin falls, you can take advantage of this position.
Therefore, even if you hold a GFJ coin as a spot asset and the value drops by 50% due to price fluctuations, you could minimize the actual damage from futures positions if you held a short position on the futures contract. This futures trading function is called “hedging”. Hedging is a tool that allows investors to minimize the risk of price fluctuations. In other words, the hedging function of the futures market is a protective key to protecting the positions of the spot market.
The hedging option on the futures markets also provides liquidity to the market. Investors can trade on the spot market with greater confidence because they can minimize investment risk by hedging their positions with futures contracts. This flow of liquidity between futures and spot markets makes the market more liquid and hence safer and more active. The higher the liquidity, the more difficult it is for someone to manipulate the market, creating a fair and transparent market.
The attraction of the futures market is that you can still make money when prices fall. Take advantage of this merit and use hedging feature to minimize risk.
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