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Hedging

Hedging what is it We are not talking about something you might find a neighbor doing to their shrubs in their back yard.  This is the other type of hedging the kind you do in the stock market.  Hedging is a practice every investor should know about.  There is no arguing that portfolio protection is often just as important as portfolio appreciation. Even if you are a beginner you can learn what hedging is how it works and what hedging techniques investors and companies use to protect themselves. 

The best way to understand hedging is to think of it as insurance. When people decide to hedge they are insuring themselves against a negative event. This doesn't prevent a negative event from happening but if it does happen and you're properly hedged the impact of the event is reduced. For example if you buy house insurance you are hedging yourself against fires breakins or other unforeseen disasters. 

Portfolio managers individual investors and corporations use hedging techniques to reduce their exposure to various risks. In financial markets however hedging becomes more complicated than simply paying an insurance company a fee every year. Hedging against investment risk means strategically using instruments in the market to offset the risk of any adverse price movements. In other words investors hedge one investment by making another. 

When you hedge you reduce your risk but you also reduce your potential profits. A reduction in risk will always mean a reduction in potential profits. Hedging for the most part is a technique used to limit loss and not necessarily a way to make money.  If the investment you are hedging against makes money you will have typically reduced the profit that you could have made and if the investment loses money your hedge if successful will reduce that loss.  In part 2 of this commentary later this week we will discuss different ways to hedge your investments both short and long term.  This topic may be of interest to you now that the market could be on the brink of a melt down.  We are not saying the market is doomed all we are saying is if that should happen your hedging should you decide you want that insurance could limit any damage to your bottom line.







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