Hedging

What Does Hedging Mean?

Hedging is the act of reducing the risk of investing in a company by making additional investments, usually in the stock market. The goal is to diversify investments to ensure that if one investment under-performs, another is likely to make up for it by yielding some profit.

Insuranceopedia Explains Hedging

Hedging is often compared to buying an insurance policy because both involve risk transfer. A real estate owner, for instance, might insure a building they own in order to be able to rebuild it and not suffer an extreme financial loss if it ever burned down. But if a fire never breaks out in the building, the premium payments will simply have been a kind of predictable loss for the policyholder.

The same principle applies to hedging in the world of stocks. An investor purchases shares in a company because they are confident that the shares will eventually increase in value. But because there is a possibility that it won't, the investor also buys shares from another company to offset any future losses. Those additional stocks, then, are a kind of insurance for the ones purchased initially.