What Is Hedging?
The best thanks to understand hedging is to consider it as a sort of insurance. When people plan to hedge, they're insuring themselves against a negative event to their finances. this does not prevent all negative events from happening, but something does happen and you're properly hedged, the impact of the event is reduced. In practice, hedging occurs almost everywhere and that we see it a day . for instance , if you purchase homeowner's insurance, you're hedging yourself against fires, break-ins, or other unforeseen disasters.
Portfolio managers, individual investors, and corporations use hedging techniques to scale back their exposure to varied risks. In financial markets, however, hedging isn't as simple as paying an insurance firm a fee per annum for coverage. Hedging against investment risk means strategically using financial instruments or market strategies to offset the danger of any adverse price movements. Put differently , investors hedge one investment by making a trade another.
Technically, to hedge you'd trade make off-setting trades in securities with negative correlations. Of course, nothing during this world is free, so you continue to need to buy this sort of insurance in one form or another. as an example if you're long shares of XYZ corporation, you'll buy a put choice to protect you from large downside moves - but the choice will cost you since you've got to pay its premium.