Hedging Against Trading Portfolio Risks

Hedging is one of the most commonly used financial words which denote any practice to reduce or remove future loss associated with an investment or instrument. Hedging is like insurance; actually insurance is also a hedge. Today one can hedge against almost all type of future losses including disasters, market volatility, robbery, inflation, interest rate changes, and more. Hedging do not stop these events from happening but enables a person to reduce the effect (loss) of the events.From a trader or investor point of view, hedging is trading or investing in instruments with negative correlations; i.e. if one goes up then the other goes down. Usually, stock traders hedge their portfolio risks by using derivatives – futures and options.Futures are the most widely used hedging method; mostly practiced by institutional traders, companies and other big players of the market. Futures can be used for both short and long-term hedging. Futures allow the holder to buy or sell the underlying product at a set price at a future time. Thus if the stock that one is holding is likely to go down, he can trade a futures contract to sell the stock for a fixed price (around current market price) to hedge his loss.Options are flexible (also can be complex) instruments which are very good hedging instruments for retail traders. Options allow the trader the option to buy or sell the underlying product at a set price at future time; remember there is no obligation.Hedging includes costs and precise market timings; and it as it reduces your risks, it also reduces the return. Most retail traders in their trading life do not practice hedging. They let their investments to grow/fall with the market. But it is worthy to learn various hedging practices, its effects, and its advantages and disadvantages.