For those who are beginners to hedging, it may seem like a challenging prospect. However, if conducted correctly, hedging is an excellent way of minimising financial risk and losses.

We’ve partnered with hedging experts from JCRA, to bring you a concise guide on hedging, so read on to see how it could benefit you.

What Is Hedging?

In layman’s terms, hedging can be defined as ‘insurance’. More specifically, the term refers to the art of transferring or offsetting risk.

Hedging techniques are used by investors, corporations and even individuals to reduce their vulnerability to risks. For example: if an individual buys car insurance, they are hedging themselves against theft and breakdowns. Whereas investors hedge one investment by making another.

Whilst hedging may seem complicated at first, it’s a common risk management technique used by many to cut their losses.

Why Do Investors Hedge?

The volatile nature of the financial market means that investors leave themselves vulnerable to risks that could result in a significant negative impact on themselves or their firm.

This is where hedging comes in. The goal of hedging is not to make money but to protect the individual or the firm, by reducing the risk of incurring substantial losses. This is usually used as a short-term strategy to protect long-term position.  

Are There Any Downsides to Hedging?

As with many risk-management techniques, there are downsides to hedging. These are:

• Not as precise as insurance – It should be noted that insurance is much more precise than hedging. With insurance you are compensated for your loss, whereas hedging is not an exact science and things can still go wrong.

• Hedging cuts into an investor’s potential reward – As with insurance, hedging costs money. If the initial investment produces profits as planned, then the hedging would have been an unnecessary expense and the investor receives less profits.

• It is almost impossible to achieve the perfect hedge – The ‘perfect hedge’ is achieved when all market risk is eliminated. However, in practise this is extremely difficult to achieve.

Should You Start Hedging?

Hedging is a viable option for anyone looking to make significant investments in stocks, however it can be difficult to get started.