There are two basic types of participants in commodities markets–hedgers and speculators. Hedgers seek to minimize and manage price risk, while speculators take on risk in the hope of making a profit.
As an example of a hedger, you might be a large corn farmer wanting to sell your product at the highest possible price. However, unpredictable weather may create risk, as well as excess supply that could drive prices down. You could take a short position in corn futures, and if prices fall, you could then buy back the futures at a lower price than you previously had sold them. This would help you offset the loss from your cash crop and help minimize your risk. Of course, if prices rose, you’d lose money on the futures transaction, but the idea is to use futures as a hedge.
A speculator—including individual investors and professionals such as hedge funds or managed futures traders, could take the opposite side of the hedger’s futures transaction. That participant would bear the risk that prices are going to rise in hopes of generating a profit on the long futures position. Most likely, this type of speculator has no actual stake in the business, other than futures trading. A commercial food producer in need of the raw product (a breakfast cereal processor, for example) may also take the other side of the short hedger’s trade to offset the risk of paying higher prices for the commodity. If the price of corn rises, the commercial food producer could still capture a profit from the futures position, even though he’d be paying more for the actual corn.
An individual trader who commits his or her own capital to act as speculator on a particular exchange provide market liquidity by constantly buying and selling throughout the trading session and are viewed as important participants in the market by shouldering risk. While the term local has been used to designate those trading in the open-outcry markets, this era of electronic trading is making the phrase a little obsolete. However, their function as liquidity providers is equally important in electronic markets. The Commodity Futures Trading Commission defines this new breed of electronic traders “E-locals,” but they are often more simply known as independent traders.