Hedging or limiting your losses are the strategy adopted only by the most sophisticated investors. These often complex strategies are restricted to evolved investors. At Mentes Kapital our aim to ensure that our clients’ money is smart money and smart money always wins. Irrespective of the market turmoil.
The best way to understand hedging is to think of it as insurance. When people decide to hedge, they are insuring themselves against a negative event. This doesn't prevent a negative event from happening, but if it does happen and you're properly hedged, the financial impact of the event is reduced. So, hedging occurs almost everywhere, and we see it everyday.
For example : if you bet on the outcome of India Pakistan Cricket match with your friend for Say Rs 100/- you can hedge your bet by betting in the opposite way of your first bet with another friend. Then you do not care what is the outcome because irrespective of the outcome you will receive and pay cash from one to the other friend.
Portfolio managers, individual investors and corporations use hedging techniques to reduce their exposure to various risks. In financial markets, however, hedging becomes more complicated than simply paying an insurance company a fee every year. Hedging against investment risk means strategically using instruments in the market to offset the risk of any adverse price movements. In other words, investors hedge one investment by making another.
Technically, to hedge you would invest in two securities with negative correlations. Of course, nothing in this world is free, so you still have to pay for this type of insurance in one form or another.