Hedging is a risk management strategy used to reduce the potential impact of unfavorable price movements in financial markets. It involves taking a second position that offsets the risk of an existing investment. The goal is not necessarily to make extra profit, but to limit potential losses.

Hedging works by balancing one risk with another position that moves in the opposite direction.

Investors and companies use hedging to protect themselves against fluctuations in currencies, interest rates, commodity prices, or stock markets. For example, an investor holding shares may buy a put option to protect against a possible price decline.

If the share price falls, the gain on the option can partly or fully offset the loss on the shares. Hedging can reduce volatility and increase predictability, but it often comes at a cost, such as paying a premium for an option or accepting lower potential upside. A hedge rarely eliminates all risk, but it can make financial outcomes more stable.

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