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Hedging definition & risk mitigation strategies
If you invest, you have probably already read this term and perhaps wondered what exactly this means. "hedgen" is meant.
In this article you will not only find the definition of hedging, but also examples that make this complex strategy easier to understand.
Hedging comes from the English term "to hedge", which means "secure" means. This refers to the hedging that investors use to mitigate price risks and avoid major losses.
You can hedge with a Insurance compare. Instead of protecting yourself against risks such as fire or theft, you protect your capital against a fall in prices.
In the financial markets, hedging is a common method of minimising one's Price risk and to reduce the Neutralise risk. This reduction in the risk of loss can be Hedger (e.g. large investors) may be essential.
Hedging can generally be based on two types take place. Either you secure your position with a so-called Hedging transaction or you diversify your portfolioso that your capital is not overly exposed to a single asset class.
In the case of hedging, the hedge is created by asset class is offset by an opposite position will.
Fund for example, often have to engage in hedging in order to minimise to keep the risk for investors within reasonable limits. For example, their portfolios rarely consist exclusively of equities, as strong fluctuations on the stock market could otherwise quickly lead to heavy price losses. In a pure equity fund, diversification and price hedging is achieved through a combination of companies from different sectors and countries.
In most cases, however, funds invest their investors' money in various asset classes, including bonds, property or commodities, for example. This allows fluctuations in an asset class to be balanced out and cushioned. Investments on the financial market are always subject to a certain exchange rate risk.
Especially with a Exchange rate or one Exchange rate fluctuation can be a Targeted hedging strategy makes sense be. In some cases, a price increase in the offsetting position can help to offset falling investments. Often, the regulation that stipulates certain requirements for a hedging transaction in the securities business, for example on the stock market or in forex trading, also applies here.
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The two most common hedging strategies are the classic Diversification (spread) and the conclusion of a Hedging transaction.
Diversification, also known as Diversification is the simplest and most straightforward way to hedge your portfolio. Instead of just buying shares, for example, you distribute your capital in diversification on various assets. This is often done with bonds or property, but you can also invest in currencies, precious metals or other commodities.
By the way, you can also do this with ETFs make. For example, instead of just investing in an ETF in the SMI you can also invest a portion in a property ETF or a bond ETF.
Important here is the Correlation between the individual investments: the lower it is, the better you spread the risk. This protects you from major slumps in a single asset class.
A classic hedge is realised with the help of a Hedging transaction and often hedges a currency risk. This is usually done with Options or futures carried out. These are derivatives, i.e. financial instruments that simply represent an underlying asset. If you buy an option on shares, for example, you are not buying the share itself, but the right to buy or sell it at a later date at a predefined price.
Both instruments allow you to Purchase or sale price of an investment instrument to define in advance. With options, however, you have the choice of exercising this right on the reporting date or not. With futures, however, you must then buy or sell the corresponding investment object.
Here a Example of a put optionPut option: With a put option, investors can define a selling price of an investment for the future. Let's assume a share is currently worth CHF 12. If you assume that the value will fall in the near future, you could, for example, fix a selling price of CHF 12 for a key date in the future. If the share then actually falls and is perhaps only worth CHF 10, you will have made a profit of CHF 2.
However, such options are not only intended for risk avoidance: sometimes they are also speculative used when market participants bet on certain price risks or movements.
The largest Advantage of hedging is that you take risks for Minimise capital losses can. Diversification in particular makes this relatively simple and cost-effective.
If, on the other hand, you want to hedge using options or futures, this also has a number of advantages. Disadvantages. On the one hand, these are Complex derivativeswhich are used almost exclusively by fund managers or professional investors. If you simply want to invest passively over the long term, such complex instruments are hardly worthwhile.
They are also equipped with high costs associated with it. You must therefore be able to accurately assess how the market will develop so that you can make a profit despite the costs.
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Hedging is a Investment strategy, the to hedge against capital losses is used. There are basically two ways in which you can hedge. Either you diversify your portfolio by investing in different asset classes and assets. Or you can use hedging transactions using derivatives such as options, a forward exchange transaction or futures to protect your position.
However, these derivatives are relatively complex and expensive and are therefore used almost exclusively by professional investors.