When we make investments on any assets by hedging on it we can reduce the risk. Further, if the derivatives are used for hedging on the investment you have made, the risk calculation is done precisely. But if we are making use of derivatives for hedging there is a need for a lot of money and sophistication and one must know that to hedge the derivatives are not the only way.
Another basic way is diversification which is used for hedging that is done in a strategic manner on a portfolio that also helps in reducing the risks. One example we can consider to understand this is that suppose if one person does investment in a company that sells upmarket goods and its margins are constantly increasing. This person will be worried that if in case there is a recession that hits, it can completely wipe the market for consumption that has been spent lavishly. However, there is a way to handle this situation that is by buying the stocks of tobacco or the utility that is required for it that he can do.
Hedging The Assets By Diversification
The trade-off that this strategy has is that if the payment is high and there are a lot of jobs, this upmarket goods production companies will flourish. However there are chances that few people might want to invest in counter-cyclical stocks and as a result, this might not flourish since most people are attracted to invest in exciting things rather than these boring stocks.
One risk that these stocks of luxury goods have is that there is no telling for sure whether the hedge and the stock will move in the direction that is opposite. Sometimes there are chances that both the stock as well as hedge might drop drastically if there is the occurrence of any event that might cause catastrophe, similar to something that happens when there is a financial crisis.
An advanced type of strategy for investments is known as hedging. The principles involved in hedging are very simple to understand. Since the time the hedge fund has come into existence it has become very popular and with popularity comes criticism. Because of the constant popularity and criticism, people have started using hedging a lot.
Even though it is spread so widely, not many people understand this very well. Whether the people know what hedging is or not most of them would have done it at some point of time in their life because everyone buys life insurance these days in the hope that it will add support to the family if anything were to happen to you and this is known as a heading.