Each one who wants to invest in the stock market wants to minimize the risk of having to trade in the market. But is it easy to minimize the risk given the volatility of the market?
Let’s first understand what do you mean by hedging?
Hedging is referred to as buying an asset designed to reduce the risk of losses from other assets. Hedging in finance is a risk management strategy that deals with reducing and eliminating the risk of uncertainties. It helps to restrict losses that may arise due to unknown fluctuations in the price of the investment.
So basically, in short, a way through which the volatility of a stock or an entire portfolio can be reduced is called hedging.
Hedging is like insurance which an individual takes to cover and ensure that the near and loved ones left behind do not fall into the financial crisis. In other words, insurance helps cover financial volatility in one’s life. Similarly, hedging one’s portfolio ensures to prevent itself from any uncertainties of the event.
The main reason for investing money for the investor is protection of the capital which hedging serves but at a cost. Hedging enables an investor to reduce the risk but cannot provide complete protection of the portfolio.
Even one knows that hedging comes at a risk, still investors prefer to hedge their portfolio. Why do you think it happens? Can investor really believe that protection of capital takes place?
The reason is that even though investment is a risk which investor usually takes place but by hedging it enables to stabilise its investment by creating such a portfolio where it invests some in debt and the rest in derivatives. This generally sets off any loss of one investment against the loss in another.
Another can be that it can diversify its portfolio by investing in various asset classes to ensure that the risk is reduced and that returns are earned.
Hedging is a method used by the investor to gain maximum returns with minimum risk. It enables the investor to survive the hard market period where the market is at a great fluctuation and there are uncertainties in the market conditions.
Hedging is important for an investor where the investor is a great extent to take the risk knowing the volatility in the market keeping in mind that both capital and returns come at a risk. But still being one of the safest ways to ensure the investor at ease while trading in the market.