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Risk is a critical and unpredictable aspect of investment.
Irrespective of what kind of an investor one wants to be, having a basic knowledge of hedging can lead to a better understanding of how investors can protect themselves.
Hedging is a financial strategy that allows investors to reduce the downside of other tradeable securities, including stocks, bonds, commodities, currencies, options and futures.
While hedging does not totally eliminate the risk of losing money on investment, it lessens that risk.
Hedging against investment risk means strategically using financial instruments or market strategies to offset the risk of any adverse price movements, thus investors hedge one investment by investing in another.
Hedging may also increase the liquidity of the financial markets, as hedging encourage investors to trade across different markets of commodity, currency, and derivative markets.
Some of the common hedge strategies adopted may include but are not limited to the following:
Asset allocation: This is the implementation of an investment strategy that seeks to balance risk versus reward. While investing , the investor can hedge their risks by diversifying their portfolio into asset allocations that carry risk and assets that provide stable returns and balance their portfolio.
Structuring the portfolio: Another type of hedging is the technique of structuring whereby the investor will invest a portion of their portfolio in debt and some in derivatives. Debt gives stability and derivatives to protect the investors’ portfolio from risk.
Hedging by options: This technique involves call and put options of assets. This helps the investor to safeguard their portfolio directly.
As the market remains unpredictable, hedging provides investors with a safety net and helps to protect investors from market risks. Hedging may not eliminate losses, but it may substantially reduce the impact of negative consequences.
Investors are always encouraged to always seek impartial investment advice before embarking on any hedge strategy.
Online Reporter