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Home » The Most Important Do’s and Don’ts of Financial Hedging

The Most Important Do’s and Don’ts of Financial Hedging

The world of investing is certainly an alluring one. You only need to glance at the sums of money that move through the world’s largest stock exchanges to understand why so many budding entrepreneurs are taking what money they have and investing it in a variety of opportunities.Investing is now easier than ever before, thanks to the rise of mobile investing platforms. There are now numerous web and app-based investment solutions that have removed one of the last remaining barriers between the average person and an investment portfolio.

Unfortunately, while investing has become easier than ever before, it is still an undertaking fraught with risk and unpredictability. It is possible to invest cautiously, and this can in some cases greatly reduce the amount of risk that you are exposed to. One of the more common tactics used to reduce risk is that of hedging.

What is Hedging?

The simplest way of thinking about hedging is viewing it as insurance. When an investor hedges, they are in effect insuring themselves or their investments against a negative event. A negative event would be any shift in the value of an investment that works against an investor. So, if an investor has bet that a stock will increase in value, then its decreasing in value would constitute a negative event.

Hedging doesn’t do anything to prevent negative events from occurring but, by giving up a small amount of the potential profits, it does allow investors to protect themselves from any losses that they do incur. When you buy insurance, you are engaging in a form of hedging. Consider flood insurance, for example. In this case, you are hedging against the possibility of your property being flooded. You are hoping that this doesn’t happen, but if it does then you are in some way protected from it.

The Dos

Before you even think about hedging, make sure that you understand the steps involved. You need to do as much research as you can beforehand. You should know the steps you are going to take off by heart before you embark upon any of them. The more research you do beforehand, the better your chances of success will be.

If you encounter any terminology that you are unsure of when researching hedging, then be sure to find out exactly what it means. For example, if you haven’t heard of FX hedging, then you can find information on FX hedging from JRCA, who provide a detailed explanation into what it is, as well as information on mistakes to avoid. You don’t want to proceed while you are in any way uncertain about what you need to do or how to best go about doing it.

Finally, make sure that you don’t use hedging as an excuse to take risks that you can’t afford. Hedging can help to mitigate some of the risks you face when investing. It does this by minimising your losses, but it won’t prevent you from losing any money at all. Never invest money that you can’t afford to lose.

The Don’ts

If you plan on hedging an investment, it is important to remember that in doing so you are restricting the amount of money that you can make as well as lose. This is because, in order to hedge, you choose two assets which are negatively correlated. Therefore, movement of the market in one direction will make you money and one won’t, but even when the market moves in your favour, the asset you’ve hedged will drag down your profits.

Financial hedging is a great strategy to protect yourself against potential losses. It is an investment option which is best suited to the more cautious and patient investor. It is not something that should be entered into before ensuring that you fully understand what you are doing and how you will do it.

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