In India, there are a lot of traders in the market who deal in Steel, Rubber, and Diamond business. The risk in trading is always associated with a sudden rise and fall in the prices of these commodities. Let us understand the same with an example. As a trader, you have purchased 10,000 kg Steel at a price of Rs.1000 per kg by paying 1 Cr and it would take 60 days to sell this 10,000 Kg in the market after adding your commission. In the meanwhile, due to less demand in the market, the prices of Steel fell to Rs.800 per kg. Now, what is the solution? You are staring at a big loss, huh!! Don’t worry, here, the role of exchanges like the Indian Commodity Exchange comes into the picture. They basically provide you the insurance against the fall in price, how?
The day you purchase 10,000 Kg of Steel by paying 1 Cr, had you sell future contracts of the value equivalent of Steel on ICEX platform, you would have earned the money when the price of steel fell to Rs. 800 from ICEX exchange. So, your loss in physical Steel price could have compensated by earning in exchanges. This is called hedging or insurance against the fall in price.
For more understanding, let us watch this video:
What is Hedging or Insurance?
How it Work?