In the uncertain world of investing, hedging provides investors with a proactive shield, i.e., a defence against downside risks. On a fundamental level, hedging means taking a position that offsets potential losses in your main investment.
As an investor, you can look at hedging as insurance for your . It is essentially an investment made with the intention of mitigating the overall risk of adverse price movements in an asset.
To put it simply, hedging is a concept that involves using financial instruments or strategies such as derivatives, options, futures, or across instruments such as stocks, bonds, and , to reduce or offset potential losses in a portfolio.
Why does hedging matter?
- Hedging, therefore, is a risk-management strategy used by investors, traders, and companies to mitigate exposure and reduce risk from adverse market moves.
- It is crucial to note that it does not eliminate risk completely. Still, it limits the impact of negative price movements.
- Hedging has become increasingly significant in recent times, as volatility across equities, , and currencies has risen.
- Currently, the primary contributors to financial market volatility are the , the ongoing and other significant geopolitical issues.
How investors can hedge — practical tools for Indian markets
- Derivatives: Use of futures, forwards, options or swaps to take offsetting positions. For example, buying a put option against a stock you own.
- Diversification-plus-hedge: Combine a spread across assets, such as equities, bonds, and , with targeted hedging to guard against systematic risks.
- Currency and commodity hedges: Especially for businesses or portfolios with exposure to foreign currencies or raw materials, using forwards or futures to lock in rates or prices.
Key considerations before you hedge
- Cost vs benefit: Hedging comes at a cost premium and incurs margin and trade fees. That is why the benefit must justify the cost.
- Time horizon: Hedging is more meaningful when you expect risk in the short to medium term. Long-term “buy-and-hold” investors may rely more on diversification.
- Not a profit-making tool: The aim is to safeguard, not necessarily generate profits. Hedging, according to investment professionals, is intended to reduce risk, not just generate profits.
For Indian retail investors, hedging can play a crucial role in protecting their portfolios from volatility and losses. One simple example is increasing portfolio allocation towards bank fixed deposits from direct stocks to ride the ongoing market volatility caused by geopolitical issues.
That is why investors seeking to protect their amid global uncertainty, market swings, and rising inflation find hedging to be a smarter way to stay invested with better control of downside risk.
Disclaimer: The information provided is for educational purposes only and does not constitute financial, investment or trading advice. Investors should assess their risk tolerance and consult a qualified financial advisor before implementing any hedging or investment strategies. Market investments are subject to risks, including possible loss of principal.