Why do people trade? To make money and just to make more money, or you could also say to try that they don't lose money. It can be classified in just three simple reasons:
Hedging: Hedging means attempt to mitigate/minimize/offset your risk. When someone tries to get in to a future agreement/contract or do a trade so as he can try to possibly reduce his risk (of losing money due to change in market value). The best way to understand hedging is to think of it as insurance. When people decide to hedge, they are insuring themselves against a negative event. This doesn't prevent a negative event from happening, but if it does happen and you're properly hedged, the impact of the event is reduced. So, hedging occurs almost everywhere, and we see it everyday. For example, if you buy house insurance, you are hedging yourself against fires, break-ins or other unforeseen disasters. Hedging against investment risk means strategically using instruments in the market to offset the risk of any adverse price movements. In other words, investors hedge one investment by making another. Technically, to hedge you would invest in two securities with negative correlations. Hedging techniques generally involve the use of complicated financial instruments known as derivatives, the most common of which are Forwards, Futures, Options & Swaps. An example of a hedge would be if you owned a stock, then sold a futures contract stating that you will sell your stock at a set price, therefore avoiding market fluctuations.
Speculation: Speculation is like inverse of hedging, the process of selecting investments with higher risk in order to profit from an anticipated price movement. A speculator generally tries to take advantage of another speculator or a hedger by getting into a deal/trade contract with him for future, as he is hoping that the other party would probably be wrong about future so the contract will turn in his favor. Financial speculation involves the buying, holding, selling, and short-selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives, or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. Speculators take large risks, especially with respect to anticipating future price movements, in the hope of making quick, large gains.
Arbitrage: The simultaneous purchase and sale of an asset in order to profit from a difference in the price. Arbitrage is the practice of taking advantage of a price differential between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices. An arbitrageur would, for example, seek out price discrepancies between stocks listed on more than one exchange, and buy the undervalued shares on one exchange while short selling the same number of overvalued shares on another exchange, thus capturing risk-free profits as the prices on the two exchanges converge. Arbitrageurs also play an important role in the operation of capital markets, as their efforts in exploiting price inefficiencies keep prices more accurate than they otherwise would be.
