A hedge is an investment or trade designed to reduce your existing exposure to risk.
This process of reducing risk is called “hedging“.
A hedge is a way to reduce the risk of adverse price movements in an asset.
In other words, a hedge is an offsetting position taken to protect against potential losses.
For example, if a trader owns a stock and fears that its price might drop in the future, they can purchase a put option (an agreement that gives the owner the right but not the obligation to sell a specific commodity or financial instrument at a specific price within a specific time) on that stock.
If the stock’s price does indeed drop, the put option’s value would rise, thus offsetting some or all of the losses from the decline in the stock’s value.
In the context of forex trading, hedging might involve taking a position in a correlating currency pair. For instance,
if a trader has a long position in EUR/USD and wants to hedge against potential losses, they might take a short position in another currency pair that typically moves in the same direction as EUR/USD.
It’s important to note that while hedging can protect against losses, it can also limit potential gains.
Also, it requires a good understanding of market dynamics and can involve additional costs, such as the costs of trading and maintaining the hedging position.