Hedge Definition: What It Is and How It Works in Investing

In the context of finance or investments, “unhedged” generally refers to a position or portfolio that is not protected.

This often means it is not protected against potential losses due to changes in market conditions or other factors.

This means that the investor has not taken steps to limit their exposure to risk, such as by using financial derivatives or other hedging strategies.

An unhedged position may be considered to be riskier than a hedged position, as it is more vulnerable to market fluctuations and other unpredictable events.

What Is A Hedge?

A hedge is a method used in investing to limit the risk of loss associated with a portfolio or investment position. Typically, this is accomplished by holding offsetting positions in other assets, such as derivatives, that will increase in value if the first investment loses value.

There are numerous types of hedges, however, the following are some examples:

Short selling is the practice of selling a stock you do not own in the hopes of purchasing it again at a lower price in the future.

Futures contract: A legally enforceable agreement to purchase or sell an item at a certain price and date in the future.

Options: Contract that grants the holder the right, but not the responsibility, to buy or sell an underlying asset at a specified price by a specified date.

Hedging can be used to protect against a variety of hazards, including market risk, interest rate risk, and currency risk.

By minimising their exposure to these risks, investors can lower the potential of large losses and enhance the likelihood of making a profitable investment return.

Importantly, hedging does not guarantee a profit, but it does attempt to reduce the risk of losing money.