Hedging reduces risk by taking offsetting positions in related assets. The goal is not to make money. It is to reduce the chance of losing it. An airline worried about fuel prices can buy futures contracts that rise in value if oil prices climb. A farmer worried about a price drop can sell futures to lock in a price. A company with overseas revenue can use currency contracts to protect against exchange rate swings.

Hedging works by pairing a position with an opposite one. If one loses value, the other gains. The net effect is a smaller swing in either direction. Hedging cannot eliminate risk entirely. It can reduce it. The cost is often a lower potential return. A hedged portfolio sacrifices upside to limit downside. That trade-off is worth it when the risk is unacceptable.

Not all hedges work as intended. Basis risk arises when the hedge is not perfectly correlated with the underlying exposure. A hedged position can still lose money if the relationship breaks down. Overhedging can turn a hedge into a speculative bet. Hedge accounting rules are complex. Companies must document their hedges carefully. When done well, hedging provides stability and predictability. When done poorly, it adds cost and confusion without reducing risk.

Common tools

• Futures contracts
• Options
• Swaps
• Forward contracts
• Inverse ETFs