What does "hedging" aim to achieve in finance?

Hedging is a financial strategy designed to reduce the risk of adverse price movements in an asset. By using various financial instruments or market strategies, such as derivatives like options and futures, investors can offset potential losses in their investments. The main goal of hedging is not to eliminate risks entirely but to minimize their impact, thereby providing a level of protection against unfavorable fluctuations in prices.

For instance, if an investor holds shares of a stock and is concerned about a possible downturn, they might purchase put options on that stock. This way, if the stock's price decreases, the gains from the put option can help offset the losses from the stock. This illustrates how hedging aims to create a balance between risk and return, enabling investors to navigate uncertainty in market conditions while still retaining some exposure to potential profits.

While some may think that hedging could guarantee fixed profits or increase potential returns, that is not the primary aim of this strategy. Rather, it is a tool for managing and mitigating risk, ensuring that investors can protect their capital against unfavorable market movements.