Hedging
What Is Hedging
Hedging is a financial strategy employed by investors and businesses to protect against potential losses from unfavorable price fluctuations in a specific asset or market. By taking an offsetting position in a financial instrument, such as derivatives, hedging helps to minimize risk in another investment or exposure. The primary goal of hedging isn't necessarily to generate profit, but to manage or reduce risk, ensuring that unexpected market shifts do not significantly harm a portfolio or a company's financial stability.
Hedging works similarly to insurance. Just as you would insure your home against potential fire damage, investors or companies use hedging to safeguard their investments or operations from financial losses. For instance, a company reliant on oil might hedge against rising oil prices by locking in a future purchase price through a futures contract. If oil prices increase, the company is protected from the financial impact, as they have already secured a lower price, thereby mitigating the risk of price volatility.