I do get it when some corporate needs their various currency , or oil to hedge against potential adverse price movement. why do some small trader/ hedge fund use hedging to minimize lost? why not just close the position or minimize the position?
You hedge for two reasons: minimize risk you cannot exit (for liquidity for example) or isolate risks you don’t want (buying Spx puts to hedge a long only portfolio).
It can get quite complicated actually, and agree with @newwurldmn, my situation is drawdown, I prefer to keep drawdown very low. I will hedge on top of a hedge so as to profit on the underlying in case of reversal patterns not reversing, hedge at earnings time, don't want to sell stocks cause they pay good dividends. ALL of my long term trading in commodities is going against major trends, normally catching 5-15% profitable trades each year, selling/buying new contract base on 9 year durations extremes, so gotten use to many breakevens and occasional losses, some breakeven trades do get to first and only target which are very decent but only 10% of positions. I will use options of underlying, use stock options to hedge futures and vis versa, in stocks I have many shorts to hedge part of the longs in stocks, and futures to hedge both stocks and other futures. I don't see why getting out of a major 1-9 year trend cause market is retracing, market might not retrace enough to add on more positions and I would lose out if I couldn't get in back on way up/down. To me the big money has generally been long term, there are times some markets like Eurodollar was going nowhere for seven years, but these are opportunities for the trader to learn other ways to generate profits by learning other ways to do so. Options, selling naked, spreads..etc I have my doubts that Hedge funds actually hedge much, one manager said it is a term to have clients feel warm and fussy. If they were actually hedging, would they have so large of loses? And can't say size matters, Buffet uses options in huge numbers.
Hedge Funds started out going safe with hedging, but now they do whatever they possibly can to make big returns. Old name that stuck.
There a lot of hedge funds of all sizes and all types, so it is difficult to summarize them. In general, most focus on one strategy. Within that strategy, their goal is to provide risk-adjusted returns for their investors to the best of their ability. Their goal is not to beat the S&P 500. Wealthy investors and allocators of all sizes look to fill an investment bucket. E.G. If a fund has a focus on health care. The investors want the fund to offer the best access to a long or long/short portfolio of health care stocks. If it is a long health care fund, the investors do not expect to make money when health care stocks drop, but they expect to do better than some ETF. That health care fund fills a need or bucket to invest in that industry. The way members here evaluate a fund or manager is not the same way an allocator would.
The liquidity of the instrument might vary, so putting on & taking off positions could add risk. Options hedgers pay premium, but keep upside potential Futures hedgers pay no premium, but lose upside. Hedging of any size locks in profit or provides protection.
Why hedge? First there is legitimate commercial hedging and this could include concentrated stock. Second is retail - I want to participate in one of three directional/volatility moves and not get killed if I'm wrong. Long/short fund hedging like 120/20 - lets me leverage up a bit and still possibly survive an extinction event. Think of a call option as a hedged long position equal to Long stock + long put. Hedging may reduce my capital requirement. Portfolio margin recognizes hedges if your broker is doing it right. Would I be better off with a smaller unhedged long position - perhaps, but you need to define the extinction event. What are the two biggest lies in the industry? I'm hedged and I'm perfectly hedged. Go to markets or products that can't be hedged and you'll see a lot less volume than in markets(sometimes countries) where hedging can be accomplished.
there's some courses advertise to retail investor on hedging strategy. it's like expecting these retail investor to have multi-million dollar trading account. perhaps a gimmick to make retail investors think they are cool to learn hedging.
The real problem is the definition of the use of the term hedging by professionals vs amateurs. A professional hedges when they buy a put option to protect from downward movement on a long position, for example. Or entering into a forward or futures contract to lock in the future delivery of a commodity they use or produce. On the other hand, punters, especially in forex, seem to think that opening an identical and opposite position to the one you currently have, while maintaining the position you already have, is "hedging". It's not, it's just ignorance. There can certainly be a reason for the former, there is seldom if ever a legitimate reason for the latter given that simply closing your original position has an identical impact and saves you paying double the commission. Bizarrely the punters are oddly passionate about their ignorance in this area, in fact you can probably expect a few protests to come out about this post!
The only time I have hedged is when I've been heavily long on the Dow index value via spreadbets. The most serious risk is obviously a fast collapse in the index, so at that time I will also have short spreadbets on individual stocks which are falling. If these are going down while the Dow is rising, then you can imagine what happens to their prices if the Dow suddenly drops due to a market shift to risk-averse.