An investment used in order to benefit the stability of an asset through reducing a risk of adverse price movements. Most of the time, “hedging” involves assuming an offsetting position in regards to a related security investment.
When most people sit down at a roulette table, they take risks by only placing money on black or red, one number or another. But occasionally someone sits down and places money on black AND red. Why? Such a bet ensures that the individual will win no matter what. “Hedging” one’s position helps to benefit the stability of any single asset, movement, decision, etc.
In investment terms, hedging serves as an insurance policy by reducing potential risk of price movements within a relevant market. However, it also serves as a reward-related tradeoff, as taking an offsetting position in related securities can diminish potential gains made in one’s investment strategy overall. Most often, hedging is done through investments in derivatives used to offset potential risks in underlying securities or comparable derivatives. Diversification in targeted ways is also commonly used as a hedging strategy.
Executive One: “Why does our accountant tell me that we donated the same amount of money to both candidates for president?”
Executive Two: “Gotta hedge our bets. We don’t want to piss either candidate off because we’re going to need the next president to negotiate some beneficial trade deals in emerging markets.”