Top Tips for Hedging

by John DePutter, May 7th, 2012
 
Wondering when to hedge, or how to do it successfully? While each situation is different, the following tips may provide some guidance around when to hedge, and how to get the best results when you do.

1. Decide whether you’re hedging to lock in a good profit for your crop or to make a buck in futures. If you’re doing it because it makes sense for your farming business, it’s probably a good decision. If you’re doing it just to make some money trading futures, you’re embarking on what could be a slippery slope of painful speculative losses.

2. Use futures to reduce risk, not increase it. Use futures as a tool to increase your farm marketing flexibility. Be careful to not aggressively load up with futures in a way that actually increases the risks involved with your business. One of the biggest dangers about hedging is that there is a natural tendency for farmers to move on from a cautious farm-hedging program into heavy speculative positions.

3. Try to avoid emotional decisions. Often, farmers will stray from their plans when markets are on fire with bullish hype amid widespread media coverage.

4. Stick to your own plan. Don’t be swayed by every elevator operator, broker, banker and neighbour. It’s your money, not theirs. Know what a good, profitable price is for your crops. Keep your own basis records; your own price records; your own track record with regard to selling cash grain and to hedging. Base decisions more on your own profit objectives and your own risk management needs, rather than on other people’s ideas. Take an approach that is suited to your own personality and comfort level.

5. Beware the ego. Your hedging goals should be directed at increasing profits and managing downside risk for the crops you grow, rather than “being right” or “looking smart.”

6. Beware the various forecasts that are readily available and often free. Good hedgers put their time into developing careful strategies and are not obsessed with forecasts. Good hedgers realize outlooks don’t always come through. Be more interested in how your business fares than on the many outlooks that are floating around. Remember: strategy is more important than outlook.

7. Be alert for special situations when hedging can be advantageous. Sometimes it’s better to manage your risk of lower prices with a short futures position instead of making an actual sale of the crop. One such time is when the basis seems to be less attractive than normal. On occasions such as this, you might want to take a short futures position for a while, waiting until the basis improves in your favour. Then when you are confronted with a better basis, you can cover the short futures position and make the cash sale. Another example of when it’s better to cover price risk with futures versus an actual sale would be when your crop isn’t harvested yet and you’re not sure about the quality of it. In this case you may not want to commit to a sale until you’re sure about the quality premiums or discounts you’ll get. In such an instance, you could hedge a portion of the crop.