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Hedging is a method of reducing the risk of loss under any eventuality. It includes nearly a simultaneous sale or purchase of equal quantities of identical commodities in two distinct markets, hoping that a negative change of price in one market is compensated by a positive change in another. Its main objective is to offset potential losses; gains may not be as high as a result of risk reduction.
A hedge can easily include various types of financial tools like swaps, options, future contracts, exchange traded funds, derivative products, etc. Because of the wide range of distinct types of options and future contracts, investors can hedge against almost everything, including currencies, commodities, stocks and interest rates.
In some cases hedging is compared to insurance but just for the sake of effective explanation. This is a strategy of insuring oneself against negative eventualities. This strategy, is not a complete guarantee, however, one can reduce its impact once they are properly hedged. Meanwhile, in case of insurance, complete compensation for losses is possible which cannot be stated for hedging.
Hedging requires buying a second asset which is in negative relationship with the first one, if the hedged security does not move as expected, the loss is minimized. Here, it is important to pay attention to the fact that hedging is not a way of making profit per se; it aims at removing uncertainty, through reducing unexpected and unfavorable risks. Risk reduction always presupposes profit reduction - hedging mainly represents a technique by which one can reduce losses but may not make money. An expected profit in case of hedging is lower than in case of not hedging, conversely, in case of sustaining losses - your hedge will reduce the extent of loss.
When it comes to financial markets, hedging against the investment risk requires using instruments to offset the risk of adverse price movements. To put it in other words, investors can hedge one investment by making another.
Before deciding to take an advantage from hedging it is important to know that each hedge has a cost which cannot be avoided. One should estimate whether the benefits received from hedging justify the expenses. This is the price that one pays to escape uncertainty.
Hedging is not only at the center of attention of individual investors and companies but also it is widely used and accepted among portfolio managers. It goes without saying that the importance of portfolio protection - hedging, is as important as its creation and appreciation. However, this is not an easy endeavor and things may go wrong at any point, since hedging a portfolio is not an exact science. Although risk managers do their best to achieve a perfect hedge, in reality it is extremely difficult.
In this concern the new method of portfolio analysis and trading GeWorko Method contributes highly to the reduction of portfolio risk. The easy to use charts, profound historical data and vast number of technical analysis tools, make it significantly easier to hedge and develop an effective strategy. Therefore, not only portfolio managers and traders, but also economists and financial analysts focus their attention on the method considering it an ideal for developing efficient portfolios.