DEFINITION of Hedge
The hedge is an investment or trade position designed to reduce existing exposure to risk.
WHAT IT IS IN ESSENCE
The process of reducing risk via investments is called ‘hedging’. A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. Simply, a hedge is a risk management technique used to reduce any substantial losses or gains suffered by an individual or an organization.
Most hedges take the form of a position that offsets one or more positions you have open. Like a futures contract offering to sell stock that you have bought. Hedging can come in many forms. For example, buying an asset that tends to move vice versa with the asset you are holding.
A hedge that removes all risk from a position, except the cost of the hedge itself, is known as a perfect hedge. But most traders will only hedge against part of their position.
A hedge can be constructed from many types of financial instruments. Including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, gambles. Also many types of over-the-counter and derivative products, and futures contracts.
Public futures markets were established in the 19th century to allow transparent, standardized, and efficient hedging of agricultural commodity prices.
They have since expanded to include futures contracts for hedging the values of energy, precious metals, foreign currency, and interest rate fluctuations.
HOW TO USE
Some brokers allow placing trades that are direct hedges. Direct hedging is when you are allowed to place a trade that buys a currency pair and then at the same time you can place a trade to sell the same pair.
Yes, the net profit is zero while you have both trades open. But you can make more money without incurring additional risk.
Forex allows traders to trade the opposite direction of initial trade without having to close that initial trade.
Well, someone can claim that it makes more sense to close the initial trade for a loss. And place a new trade in a better spot. But this category belongs to trader wariness.
A trader, could close the initial trade and enter the market at a better price. The advantage of using the hedge is that traders can keep the trade on the market. And moreover, can make money with a second trade. The one, that makes a profit as the market moves against his or her first position.
When traders assume the market is going to reverse and go back in initial trades favor, such trader can set a stop on the hedging trade, or just close it.