Hedging is a trading strategy designed to reduce the risk of adverse price movements in an asset. It involves taking an opposite position in a related asset to offset potential losses. Hedging is common among institutional investors, but individual traders also use tools like Options, Futures, or inverse ETFs. While it can limit losses, hedging may also reduce potential gains. It’s a valuable technique for risk management, particularly in volatile or uncertain market environments.
Example:
A trader buys EUR/USD expecting it to rise, but to reduce risk, they also open a short position on a correlated pair like GBP/USD.
At the same time, to protect their broader equity investments, they buy put options on S&P 500.
If the market drops, losses from the currency trade or stock portfolio may be partially offset by gains from the short position and the put options.
