In this approach, a corresponding dollar amount is taken from futures in stock trading – for example, by buying £10,000 from Vodafone and shortening FTSE futures contracts worth £10,000 (the index in which Vodafone trades). A futures contract is an agreement between a buyer and a seller to buy and sell a particular asset at a future time at a predetermined price. Producers (such as farmers) and buyers in the spot market can hedge against possible price fluctuations by buying or selling futures contracts. Changes in the spot market price should hopefully be offset by corresponding changes in the forward price. The best way to understand coverage is to think of it as a form of insurance. When people decide to hedge up, they insure themselves against the impact of a negative event on their finances. This does not prevent all negative events from occurring. However, if a negative event occurs and you are properly secured, the impact of the event is reduced. Hedging can be used in different ways, including forex trading. The above stock example is a “classic” type of hedge that is tradable in the industry as a pair due to trading a pair of related securities.
As investors have become more sophisticated, as well as the mathematical tools used to calculate values (called models), the types of hedges have increased significantly. .