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What are Hedging Strategies?
Hedging strategies are different forms of financial plans that allow a person to avoid unwanted price fluctuations in one market by establishing an opposite position in a different market. The overall goal is to limit the amount of risk faced when investing in different types of securities. A number of financial vehicles exist to benefit investors interested in hedging the chances of a large loss in markets. These include different types of options, forwards, swaps and insurance. Generally, hedging strategies involve the establishment of hedge funds to prevent the loss.
Hedge funds are designed for shorter-term investments with the goal of making the largest return on investment in the shortest time. Instead of making a small amount of money over a long period of time, these diversified portfolios generally leverage successful securities against less successful ones, providing a large return with minimal risk. The main component of a hedge fund is the risk-return ratio, which can be analyzed by tracking the performance of certain markets over a specific period of time. Generally, hedge funds are only available to investors with a large percentage of financial assets at risk.
One of the primary components of hedging strategies is the concept of options. This enables investors to take a position that gives them the right to either buy or sell a certain asset at a specific price. The bonus of the options method is that the investor is not obligated to either sell or buy the financial security. Two types of options exist within this investment format: a put option and a call option. A put option gives the investor the right to sell at a given price, while a call option allows the investor to buy at a given price.
The concept of hedging strategies were formulated in 1949 by financial writer and sociologist Alfred W. Jones. He established the first hedge fund which focused on buying assets for the portfolio that would perform better than market expectations and sell products that did not meet his minimum criteria. This system essentially created a situation in which investors were more likely to generate a profit, while mitigating the likelihood of a loss. Over the years, additional research has shown that adding other components to the mix could also benefit the success of hedging strategies. Also, by taking out insurance plans on parts of the package against other financial securities, risk is further limited.
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By: yellowjHedging strategies are different forms of financial plans that allow a person to avoid unwanted price fluctuations in a market.
Discussion Comments
Hedging is incredibly risky. It is not investing. It is "speculative trading" -- basically some form of educated gambling. Most people lose tons of money. Big investors pick up all the losses from the small. Those who have been in the game for eons own those who haven't been.
Any "Salesman" who would encourage you to gamble-trade does not have your financial interests in mind. It is speculative and can make up a small part of your portfolio, but unless you are full time active in such for years with an economic and financial education, expect to lose it all within short time.
With hedging and options, you easily and quickly lose 30-100 percent of your initial investment in short time if things go south and there is a 60 percent chance they will right out of the gate. If your fine with that risk you can give it a shot, but you work hard for your money and its hard to get back again when its gone.
Successful "investors" and banks do not gamble, or try to invest with hedging. Hedging is like and insurance policy and should only be used so. Expect to lose your insurance premiums as you would, you are paying for safety of your other investment it covers. Speculating on making money with this insurance policy is bad economics.
Probably the best thing about using hedging strategies (or so I’m told) is all of the options that you get to include in your financial portfolio. The trick is knowing what options to go with, I think.
I really wish that I knew more about financial matters such as these, but all I hear when someone starts to explain it to me is a voice like the Charlie Brown teacher’s, “Wah, wah, wahwahwah…”
So, if a person like me wanted to try out some nifty hedging strategies, what kind of different financial endeavors would I be looking to become a part of? Or should I just go ahead and hire someone to do it for me rather than try to learn hedge strategies on my own?
When I set up my 401K plan through work, the person who helped me pushed me to take on higher risk plans because I’m fairly young. He said that if I lost money initially, it would be made back and then some over time.
He also said that the older I got the less I would probably want to risk, and would want to go with more secure options.
Was the first technique he shared with me like hedging, or is hedging more short term and even riskier?
I want to make money for my retirement, but with an economy that is everywhere, it’s hard to know what to do. It seems like the ground rules are changing every day. Are stock hedging strategies right for me, or am I on the wrong track?
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