Hedging is a risk management strategy used to mitigate potential losses or gains in an investment or asset by taking a position in a related security or market. It involves reducing exposure to market volatility, price fluctuations, or other uncertainties by offsetting potential losses with gains in a complementary investment. Hedging can be used to protect against various types of risk, including price risk, interest rate risk, currency risk, and credit risk.

For example, an investor holding a portfolio of stocks may hedge against potential losses by buying put options or selling futures contracts on the same stocks. If the stock price falls, the gains from the put options or futures contracts can offset the losses in the portfolio. Similarly, a company exporting goods may hedge against currency risk by buying forward contracts or options to lock in the exchange rate, protecting against potential losses due to currency fluctuations.

Hedging can be achieved through various instruments, including options, futures, forwards, swaps, and other derivatives. The key is to identify the potential risk and find a suitable hedging instrument to mitigate it. Effective hedging requires a thorough understanding of the underlying asset, market trends, and the hedging instrument itself. When done correctly, hedging can help investors and companies manage risk, reduce uncertainty, and protect their assets.