Hedge a type of position established in the market

By: lalitearns
When speaking of finance, Hedge can be determined as a position that is established in one market in a simple attempt to offset exposure to the price risk that is equal but opposite in obligation or position when compared in another market. Hedging is nothing but a simple strategy that is designed to minimize exposure to such business risks as a sharp contraction that may be in demand of one’s inventory and all this while still allowing the business to still profit from simply producing and maintaining that inventory.

The term is simply originated from a phrase hedging your bets that is usually used in gambling games like the roulette. Understanding it more closely, we can say that the hedges as on a roulette table, may be like the lines between the numbers or even a number group. Placing a hedged bet is one where the chips lie across one or more hedges. So, the bet would then cover all the numbers involved at an approximately reduced stake like half, one third or even one-forth. So, the term simply moved into common usage and today it covers a broad range of risk-reduction activities. But, when related to finance industry, the term hedge loan may be having a more specific meaning or a type of financial product that’s based on simple price fluctuation risk in a stock that serves as collateral for a nonrecourse debt structured stock loan.

So understanding closely, a stock trader would be one who would believe that the stock price of a certain company say A would rise over the next few months due to better methods introduced by the company to produce widgets. So now he wants to buy the shares of this company in order to make profit from increasing prices. But this company A is also a part of a highly volatile widget industry and if the trader would simply buy the shares then the trade would be a speculation. Now since the trader is more interested in the company rather than the industry itself, so he decides to hedge out the risk by simply short selling shares of the company to its competitor B.

So, even if he did manage to short sell some asset the trade might have been essentially riskless. But as we all know that some risk always remains in the trade, so it is said to be hedged. May be on the second day some favorable news of the widget industry is published and the shares of company A goes up and so does the shares of company B. since both have a different profits as company B profits less when compared to company A, so the trader might regret on day two. But on the third day, may be the stock crashes and the trader suffers a loss. Since company A is a better company so its losses are less when compared to company B. without hedge the trader would have lost more, but the hedge gives him a small profit during the dramatic market collapse.

A natural hedge is a type of investment that would simply reduce the market risk by simply matching the cash flow. One of the oldest means of hedging against risk would be simply purchase insurance to protect against loss or damage or even personal injury. Sometimes currency hedging may also be used by both financial or non financial investors. Financial investors may do it to phrase out the risk they may face while investing abroad whereas non-financial investors may use it in global economy. Such hedging may either be done in a standardized contracts or with customized contracts.