A hedge is a risk management strategy that uses financial instruments to offset potential losses in an existing or anticipated position. Hedging involves taking an opposite position in a related security, derivative, or correlated asset to reduce exposure to adverse price movements. While hedges limit downside risk, they also typically reduce profit potential from favorable price moves.

Effective hedging requires understanding correlation relationships, basis risk, and the costs associated with hedging instruments. Common hedging tools include futures contracts, options, swaps, and inverse ETFs. Perfect hedges are rare due to basis risk and correlation changes, so most hedging strategies involve trade-offs between risk reduction and cost efficiency.

Real-world example: An airline hedges jet fuel costs by purchasing crude oil call options, limiting fuel expense increases while maintaining ability to benefit from fuel price declines through unhedged exposure.