A hedge is an action taken to offset the potential for an adverse price change in an asset. By engaging in a hedge, one can generate an offsetting price movement that negates the prospective adverse price change. A perfect hedge is one that exactly offsets all of the potential loss associated with a position. Hedges are commonly used to provide protection when positions are being held in the following areas:

  • Commodities
  • Foreign currency
  • Securities

There is a cost associated with a hedge, so using one will reduce the profits that might otherwise be gained, assuming there is no adverse price change in the underlying asset.