What does it mean to "hedge" investments?

To "hedge" investments refers to the practice of reducing the risk of adverse price movements in an asset. This can be achieved through various strategies that help protect against potential losses in an investment. For instance, a common hedging technique involves taking an offsetting position in a related security, such as using options or futures contracts, which can mitigate losses if the market moves against the investor's primary position.

The goal of hedging is not to eliminate risk entirely but to manage and minimize exposure to unfavorable changes in price, thereby providing a safety net for the investor. This makes hedging a critical strategy for risk management in investment portfolios, especially in volatile markets where price fluctuations can significantly impact returns.

While increasing potential returns, diversifying assets across sectors, and liquidating investments for cash are various investment strategies, they do not inherently focus on managing or lowering risk in the way hedging does. Hence, the emphasis on risk reduction is what distinctly characterizes the concept of hedging in investments.