Hedging is a financial strategy used to reduce the risk of adverse price movements in an asset. Investors often use various instruments, such as options or futures contracts, to protect their investments. For example, if someone owns shares of a company and fears the price might drop, they can buy a put option, which gives them the right to sell the shares at a predetermined price.
This strategy is similar to taking out insurance. Just as you pay a premium to protect your home from damage, hedging involves a cost to safeguard your investments. While it can limit potential losses, it may also reduce potential gains.