The term hedging originates from risk management. You may be interested in trading with Stocks, Raw materials or Fund and have looked at ways of hedging. In this article, we show you what hedging means and what options there are for hedging your own portfolio.
Hedging definition
This is a risk management strategy. The term is derived from the English "to hedge", which means "to secure". Hedging is a type of Protection for your own portfolio and is comparable to an insurance policy in the way it works.
With insurance, you can protect yourself against certain negative situations. Although these situations can still occur, you are protected against the consequences.
Hedging also works in this way and is used in the area of investment funds, for example. Here there can be risks due to price changes and the resulting fluctuations. Hedging can help with this, Limit losses and increase safety.
A fund collects money from a large number of investors. These assets are then used to invest in a specific asset class, such as shares or commodities. In order to reduce the risk of price fluctuations, a Opposing position are taken for the investment. Hedging is therefore the reduction of risks through possible opportunities from another position.
Hedging strategies
If a fund is invested in the S&P 500 is invested, can Put options on the index. Put options give the buyer a special right. They can sell a share at a certain price if they have purchased a put option. If the price of a particular company share falls, the value of the purchased option increases.
Another option is the purchase of Futures contractswhich works in a very similar way. Here, a contractual obligation to buy or sell is included. Unlike put options, the buyer does not have a choice, but an obligation. The price of futures contracts may rise, allowing the seller to make a profit in addition to hedging.
Hedging can also be used in the commodities sector. Commodities are sometimes subject to strong fluctuations, which is why people want to hedge. A buyer of a commodity can purchase a certain quantity of the commodity and also hedge the same quantity of the commodity as a Terminware on the day of sale of the finished product.
If the price of the raw material falls during processing into the end product, the goods are sold at a lower price. Nevertheless, he can buy the required raw materials more cheaply and compensate for possible losses in this way.
In somewhat broader terms, the term hedging can be used for all possible measures that relate to the protection of the portfolio. The Diversification is often mentioned in connection with hedging. Investment positions should correlate with each other as little as possible so that the risk of a large loss can be minimized and the risks can be spread across different investments.
Hedge trading - note the costs
The cost aspect should not be neglected when hedging. Costs are incurred for every new position opened. Investors should therefore carefully consider which investments require hedging and which do not.
Hedging makes sense, for example, due to low risks or costs. Hedging can also make sense if the original trade is associated with high risks and can therefore lead to heavy losses.
The additional capital for the costs should always be taken into account. Having your own budget can help you to avoid overspending. An investor's financial resources and risk tolerance also determine when they should and should not opt for hedging.
Conclusion: What does hedge mean?
"Hedge" means "to protect" and is an important term in risk management in relation to financial investments. Investors can protect their own portfolio by taking certain measures. To do this, they can create offsetting positions to compensate for possible losses.
One example is put options, which give the buyer the right to sell a share at a certain price. Futures contracts work on a similar principle, but involve an obligation to buy or sell. Hedging is also used in commodities trading.