What Is Hedging?
Hedging is a risk management strategy used to offset potential losses by taking an opposite position in a related asset.
It involves taking a derivative position to balance exposure and protect against volatile price movements.
Common hedging instruments include futures, options, swaps, and forward contracts.
Hedging can be used by commodity producers/consumers to lock in prices and protect profit margins.
Investors can hedge to limit downside risk in a portfolio without having to liquidate assets.
Companies hedge to mitigate currency, interest rate and commodity price risks.
Hedging does not prevent losses entirely but provides protection against significant swings.
Effective hedging requires understanding correlations between the hedged asset and hedging instrument.
Poor hedging can be costly if not implemented correctly, including basis risk, over-hedging.
Hedging strategies include long hedges, short hedges, stop-loss orders, and options strategies like straddles.