Are you sick and tired of losing money in the stock market? Keep reading because in this article I am going to give you a stock market tip that will help you to pout a stop to this.
This stock market tip is called, “hedging” and is a practice that every investor should know about. The best way to understand hedging is to think about it as insurance. When people hedge they are insuring themselves against a negative event. Hedging does not stop negative events from happening but it does lessen their impact.
Hedging against investment risks means strategically using instruments in the market to offset the risk of adverse price movements. In simpler terms investors hedge one investment by making another.
To hedge you would invest in two securities with negative correlations. Take note that hedging will affect your risk return trade off. A reduction in your risk will always mean a reduction in your profits, thus hedging is not a technique that you can use to make profits instead it is used to reduce potential loss.
How to hedge
Hedging techniques involve the use of complicated financial instruments know as derivatives, the two most common ones being options and futures. Here is an example of how it works, lets say you own shares of Xyz Company and want to protect yourself against potential losses. To do this you can buy a put option on the company, this gives you the right to sell your stock at a specific price.
This strategy is known as a married put. If the stock price goes beneath the strike price the losses will be offset by gains in the put option. There are many different hedging techniques but this is the simplest.
For all its benefits this stock market tip has its downsides, every hedge has it’s costs so decide before hand if the benefits out weight the costs. Remember that the goal of hedging isn’t to make money but to protect against losses, also hedging is not a perfect science and things can go wrong.