What is meant by "hedging" in trading?

Hedging in trading refers to a strategy designed to offset potential losses in an investment. This is typically accomplished by taking an opposite position in a related asset or using financial instruments such as options, futures, or swaps to mitigate risk. For example, if an investor holds a stock and is concerned about a potential decline in its price, they may purchase a put option on that stock. This allows them to sell the stock at a predetermined price, effectively limiting the potential loss they would face if the stock’s price falls.

The essence of hedging is risk management rather than the pursuit of profits. It involves creating a safeguard against unpredictable market fluctuations, ensuring that an investor is better protected against adverse movements in asset prices while still allowing for some potential gains. This distinction makes it clear that hedging is focused on minimizing loss rather than merely maximizing returns or increasing investments.