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Hedging is a risk management strategy employed to offset potential losses in investments by taking an opposite position in a related asset. In the context of energy commodities trading, hedging involves taking a position in a futures or options market to reduce the risk of adverse price movements of the underlying physical commodity, such as oil, natural gas, or electricity. For example, an oil producer might hedge against the risk of falling crude prices by selling oil futures contracts, thereby locking in a price for their product at a future date.

Companies, investors, and traders use hedging techniques to manage their exposure to price volatility, currency risk, or changes in interest rates. The main purpose of hedging is not necessarily to gain from the hedge itself but to protect from losses on the main investment or business activity. Common financial instruments used in hedging include futures contracts, options, swaps, and forwards.

While hedging can limit potential losses, it can also limit potential gains. When a favorable price move occurs, the gains from the protected asset can be offset by the losses from the hedge position. Thus, hedging is often considered a form of insurance that comes with a cost, which is the price of the hedge itself.

For further reading and a deeper understanding of hedging, please refer to the following resources:

1. Investopedia – Hedging: This provides a comprehensive overview of hedging, including its purposes, strategies, and examples within the financial and investment realms.

2. CME Group – Hedging with Futures: This offers detailed insights specifically into hedging with futures contracts, which is especially relevant in the context of commodity trading.

These references are leading resources that offer foundational and up-to-date information on the practice of hedging within the financial and trading sectors.

This A.I.-generated glossary is intended to provide a convenient means to understand terminology used on this website in the context of physical commodities trading. Some terms may have alternative and/or expanded definitions that may not be relevant here and thus not included. Sources provided are for reference and not intended to be an endorsement of the broader content on that website. Suggestions, questions, or corrections can be provided in the comment box on definition pages.