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What is hedging in trading?

In one line: Hedging is taking a second position designed to offset possible losses on a first one, like insurance that costs something to hold.

Trading glossary · Updated 2026-10-21

A simple example

You own 100 shares of a stock at $50. That's $5,000. Earnings are next week, and you'd like to limit how much a big drop could cost.

You buy one Put option with a $45 strike for $1.50 a share. One contract covers 100 shares, so it costs $150.

• If the stock falls to $35: the shares lose $1,500. But the put lets you sell at $45, so the share loss is capped at $500. Add the $150 cost: about $650 total loss.
• If the stock rises to $60: the shares gain $1,000. The put expires worthless. You're up about $850 after the $150 cost.

The hedge cut the worst case a lot. It also cost money on the good outcome. That's the trade-off.

Why it matters

Every hedge has a price:

• Options cost a premium, which fades with time. See Theta.
• Offsetting positions cut your gains as well as your losses.
• Hedges can be imperfect. If the two markets don't move as expected, both can lose. That's a Correlation risk.

Big investors and companies hedge all the time, for example a business locking in a currency rate months ahead.

Hedging vs a stop loss

A Stop loss gets you out. A hedge keeps you in while softening the hit. For most single trades, a stop is simpler and cheaper.

Note: in the US, NFA rules generally don't let retail forex accounts hold a buy and a sell on the same pair at once. It would mostly just add costs anyway.

A common mistake

"Hedging" a losing trade instead of closing it. Opening an opposite trade to avoid taking a loss locks the loss in place while adding spread and costs. It just delays the decision.

Questions