Let's start things off with a little anecdote. Wendy the weatherwoman has an important forecast to make today. A storm is rolling in but she is not sure whether it will hit the big city, causing a massive catastrophe or will take a right turn and head out to sea. However, she must report the weather as millions of citizens depend on it. To "hedge her bets" Wendy simply says the storm may come and hit land or head out to the ocean. That way, she covers all of her tracks and cannot be blamed for either occurrence.
Now, what does this have to do with investment? Well, a hedge investment strategy is quite similar to the one Wendy just used right there. Confused? Don't worry. We'll get down to business right away.
Much like Wendy, a hedge investment strategy involves insurance. Insurance against a bad event. Now, this doesn't mean you are protected from the bad event altogether but it softens the blow of the event so the negative effects are minimal. In terms of investing and trading, individuals can use a hedge investment strategy to protect themselves from financial risks.
This is different than simply buying flood insurance though. To properly initiate hedging, one must use advanced techniques found in the market to minimize the damage from price movements. In simple terms, to protect yourself from one bad investment, you must make another good one. It's not a strategy that makes you money (for the most part) but it will keep you from losing it.
Hedge investment strategy experts utilize instruments called "derivatives." We could go on a deep, technical analysis about derivatives but seeing as this is an introductory article, let's keep it simple for now. Let's pretend you buy Apple stock. However, you've heard some recent news and you're afraid that Apple stock will drop in the short term. Hence, to protect yourself from these losses, you buy a derivative in the form of an option or future. This gives you the option to sell Apple stock at a certain price. Hence, if the stock falls below that price, your losses are insured by gains in the derivative which you purchased. Remember, this is just a very basic explanation of derivatives. There are several different kinds of futures and options. We'll get into that later but for now, a final thought.
Even if you don't utilize the hedge investment strategy in your own investment, it's important you know what it's all about. Everyone hedges against something. Advanced cryptocurrency, decentralized exchanges like Kelvin will hedge against fluctuations in the crypto market and big oil companies like Shell hedge against the price of crude oil. Essentially, it helps to know how companies protect themselves against the often hostile market. Knowing this not only helps you become more comfortable with the market operation but could save you lots of money down the line.