One of the constant concerns in the life of the investor is the security of operations against the risks of market fluctuation. In this sense, it is important to know what a hedge is and to know how the strategy can minimize the danger of investments.
We can understand hedge as a protection tool that you can use when investing your money on the stock exchange. Knowing the strategy and knowing how to invest wisely can help boost your profitability and reduce the risks of equity.
Do you want to know better what is hedge in the variable income market? Read on and understand the concept, know what it is for and see how to put it into practice!
What is hedging?
For those who invest in the stock exchange, hedging is a form of investment protection. In a simplified way, the strategy works in order to surround the applications and try to reduce the impact of volatility in the prices of the assets of its portfolio.
In other words, hedge is the tool that serves to protect financial transactions that are exposed to a high volatility rate. Such a concept is related to the constant price variation of an asset.
Protection can be done according to different techniques and can serve different purposes. For example, protection against changes in the exchange rate of some currency, greater security in relation to the downside of the stock exchange and possible economic crises, risk management of rural production, etc.
In some cases, hedging is a strategy that provides some kind of predictability to the equity market. Thus, it can be used to balance your portfolio.
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What types of hedges are there?
As we have seen, hedging is a way to protect your investments and there are different strategies to put it into practice. Understand below how it works in different situations.
Commodities
In relation to commodities, there are some ways to hedge. It is very common among rural producers, to protect themselves from fluctuations in the price of the harvest. For example, negotiating futures contracts to freeze a certain price at a later date.
Another protection using commodities is in relation to gold. Some characteristics of the precious metal make it one of the safest assets on the market - such as the fact that its quotation has no direct relationship with government issues in any specific location.
Gold has a negative correlation with the stock exchange. Thus, it is expected that its price will rise in periods of economic crisis, for example. The movement happens because there is an increase in demand for the asset, which is used as protection in several countries.
As the fluctuation in the price of gold occurs under the law of supply and demand, it is normal for the price to increase when the financial market is not favorable. Thus, having investments linked to gold in the portfolio can offer greater stability to the variable income investor.
Dollar
Like gold, the dollar is also considered a protective asset. It is related to the largest world economy - the United States, which has international strength, in addition to the greater volume of trading on the stock exchanges.
The US currency has strength over other currencies, such as the Real. Therefore, several governments use the dollar as a security reserve. This also causes the currency to have a negative correlation with the stock exchange.
In general, if when the stock market is falling, the price of the Dollar goes up. In economic crises, for example, it is common to see a rise in the price of the US currency. Thus, having investments linked to it can also work as a hedge.
The strategy of using the dollar as protection for the investment portfolio is called an exchange hedge. It serves both equity investors in general and, especially, those who have dollar bonds and need to protect themselves from exchange rate changes over time.
Derivatives
The derivatives market can be used for hedging. It is possible to operate with futures or options contracts in order to reduce the risks related to the volatility of your portfolio. Thus, they are also alternatives to protect the investment portfolio.
The strategy using options allows you to acquire the right to buy or sell a certain share for a fixed price up to a deadline. As such, they are used by investors to protect themselves from large price changes.
When is it worth hedging?
You just learned more about what hedging is and what types of protection may exist. But, after all, when is it worth putting it into practice? In general, investors and even companies can use the hedge strategy to mitigate risks.
Controlling risk is essential to achieve better results and even survive in the financial market. Thus, the hedge can be worthwhile when you already invest in variable income and want to protect your portfolio from any casualties in the market.
Another time when hedging can be interesting is when you need to protect money from exchange rate variation for some foreign currency commitment. For example, an international trip or the import of products.
Another context where protection is important is in rural production. Imagine a coffee producer who wants to reduce the risks of his production being sold for a very low price in the future. It can trade in derivatives to lock in a more favorable price for a date in the future.
How to hedge?
After knowing the benefits of hedging and its applications, you may be wondering how it is possible to put the strategy into practice. It is important to understand that there are several ways to hedge, as the technique may vary according to your objectives.
The investor must know the possibilities to see which are the most suitable for him. There are different ways to invest in Gold or Dollar - allocating resources in investment funds related to these assets, for example.
In addition, in general, the derivatives market is widely used for hedging. So, it is also worth knowing.
Remember, also, that portfolio diversification is also a way to protect and dilute risks. Making diversified choices helps to compensate for possible losses of some assets with the gain of others.
Did you like to know what a hedge is and how the tool works? It does not eliminate all risks from the market, but it does enable risk management and increases your protection against the weather. So be sure to analyze your portfolio and think of the best techniques for it!
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