The futures markets are organized and used not only for speculation but also for hedging, which is a method of eliminating risks arising from fluctuations in prices. Hedging may be referred to as the practice of covering the risks attaching to transactions in the cash market by contra-transactions in futures trading. If a commodity is purchased for delivery after three months in the cash market, where the actual commodity is handled, the trader may hedge the purchase by selling it for delivery after the same period in the futures market.

If the price of the commodity rises, the trader may sell in the spot market and buy in the futures market. The gain made in the cash market is offset by loss in the futures market, and the commodity is obtained at the price originally conceived for it. On the other hand, an agreement to sell in the cash market may be hedged by means of a counter-agreement to buy in the futures market. However, for such offsetting of losses, it is necessary that the prices in the cash and futures markets move in sympathy with each other.

There may be two forms of hedging: hedge sale and hedge purchase. When a person buys a commodity in cash, he may at the same time sell futures of an equivalent quantity as a protection against a fall in price during the time he holds such stock. Such sale in the futures market is called a hedge sale. If a manufacturer sells some goods for cash, he may protect himself against an advance in the price by purchasing futures for an equivalent quantity.

The basic purpose of hedging is to secure protection against fluctuations in prices. This protection is secured by shifting the risks of price changes to the professional risk-takers, i.e., speculators. A manufacturer who manufactures goods according to a carefully prepared budget can save him from the upsetting results of a rise in the prices of raw materials by hedging in the futures market.