The Basics of Hedging

Hedging is a very popular technique used by different companies for survival. You might not have used this technique and may never will but most companies do this and could easily affect your portfolio if you do not understand it.

This type of technique is used by investors to prevent complete loss of shares. They will always use this technique for their survival. You can use hedging which may give you a good chance of surviving different challenges in the economy such as inflation or drastic share drop.

This technique is often considered as insurance from complete loss. You will still lose in the end, but with hedging, you slowdown its effects which will give you a good chance of rebounding fast.

Companies consider hedging because any movement will mean millions of dollars in losses. With hedging, they are assured that losses would be at minimal and will help them forecast the future better.

Hedging Techniques

Classic Hedging – This type of hedging involves stocks and shares wherein an investor balances the portfolio with a high risk share with secured shares. The secured shares will ensure profit and will prevent complete loss posted by a high risk shares. It is almost a win-win situation but they are often seen in the negative side since high risk share could easily cost you.

Natural Hedging – This type of hedging does not use stocks or shares but it uses different investment and management techniques which will secure the company’s future. For example, a company sees a clear indication that prices of some of their raw materials could change at anytime.

Instead of taking risks, the company strikes a price with a dealer to ensure supply and price. If the prices the raw material rises the next day, the company is still in great condition.

Hedging Advantages and Disadvantages

Hedging is a good thing for companies and high risk investors since it provides them the insurance they need against complete market loss. For companies, they can assure their investors and shareholders that their status is still strong and will move forward as expected.

Through hedging, they can outline their movements in the future. Although they will experience losses, they will also anticipate how much they will loss and adjust the company strategy accordingly.

The disadvantage of hedging is the price every investor you have to pay. You do not really pay for hedging but you are sacrificing a part of your potential earnings.

As our previous example, a company sets a price with a provider to ensure that they will have an expected price. A company will be protected from the increase of raw materials but they will never save if the price of raw materials drops even at a very small level.

What Should You Do?

Hedging is not a suitable action for every investor. If you have a portfolio with small movements, hedging may not be for you. A small movement in your portfolio will not provide any significant effect in your portfolio.

However, you should know that large scale companies are always hedging to control their losses even though they will lose some. Companies who will not hedge are placing themselves in a very dangerous situation since their market position will be swayed with external factors that cannot control.

As an investor, you clearly know which company is smarter in terms of securing their future. Hedging may not be for you as an investor or a shareholder but it will affect you as the companies you invest with practice hedging. Consider a company that hedge if you want a secured company. Although your shares will not jump exponentially, it will steadily increase.