In the stock market, hedging refers to a strategy used by investors to reduce or mitigate the risk of potential losses. Hedging is done by taking an offsetting position in a security or a group of securities that are negatively correlated with the original position.
For example, an investor who holds a portfolio of stocks may buy put options on the same stocks or stock index futures to hedge against potential losses. If the value of the portfolio declines, the put options or futures will gain value, offsetting the losses in the portfolio.
Hedging is often used by investors who are concerned about market volatility or uncertain economic conditions. It allows them to protect their portfolio while still maintaining their investment positions. Hedging also comes with its own costs, such as the premium paid for options or futures contracts. It’s important for investors to weigh the potential benefits and drawbacks of hedging before deciding to use this strategy.