Hedging involves offsetting an exposure to the price risk of one market by taking out an equal but opposite position in another market. .
Hedging is a sophisticated strategy regularly employed by the big end of town such as professional traders and fund managers, particularly hedge fund operators. Many say that CFDs are one of the best hedging tools around, which means that hedging strategies are now available to ordinary investors as well.
Hedging your bets can feel a bit like you’re trading against yourself because in a sense you are. You are simply aiming to reduce your risk.
Let’s say that you hold a sizeable share portfolio consisting of BHP Billiton, Rio Tinto, a couple of the big banks and so on. Heightened sharemarket volatility and bad news emanating out of the US is making you nervous. Rather than panicking, and calling your stockbroker to sell you out of the lot (remember, there are tax consequences to deal with when you sell), you could short sell a CFD over the index, such as the S&P/ASX 200 instead. This means that if the overall market does fall, you will make the equivalent gains on your CFD trade. If the market continues to go up, well losses on the CFD trade are compensated by gains in your share portfolio.
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