Before we move on to ‘hedging’, let’s have a little understanding of what is a “hedge”. In simple words, a hedge is a type of investment and it is used to reduce the risk of price fluctuation in an asset.
Hedging for Risk Management
Hedging is a risk management practice and is similar to taking up an insurance policy to protect you from a probable future loss. For instance, if you have a house which is in a flood-prone area, you will try to protect it from the risk of flooding. This is our terms means you will try to hedge it by taking out flood insurance. In the nutshell Hedging is nothing but “protection” against the risk.
Protect from Potential Loss
Similarly, hedging of an investment gives you protection against the potential loss from the fluctuation of prices in the financial market. Hedging is done by occupying an equal and opposite positions in two different markets. Hedging also protects your capital loss against the impact of inflation through investing in bonds, shares, real estate notes and precious metals such as investing in gold.
But hedging isn’t free as it also chips away at potential gains.
With the popularity of hedge funds, hedging is becoming fairly popular in the market.
