Hedging

What Does Hedging Mean?

Hedging is the practice of reducing investment risk by making additional investments, often in the stock market. The goal is to diversify the portfolio so that if one investment underperforms, another may compensate by generating profit.

Insuranceopedia Explains Hedging

Hedging is often likened to buying an insurance policy, as both involve transferring risk. For example, a real estate owner might insure a building they own to avoid a severe financial loss if it were ever damaged by fire. If no fire occurs, the premium payments are simply a manageable, predictable cost for the policyholder.

The same principle applies to hedging in the stock market. An investor buys shares in a company, believing they will increase in value. However, to mitigate the risk of a potential decline, the investor also purchases shares in another company to offset possible losses. These additional stocks, therefore, act as a form of insurance for the initial investment.