Hedging is an investment technique to offset potential investment losses by purchasing correlated investments that are expected to move in the opposite market direction.
Hedging techniques are popular methods for investors to protect themselves from risky positions; they hedge their bets. It’s like having investment insurance. If a sudden price reversal occurs, the damage gets limited due to the hedge position.
Importers and exporters often employ hedging strategies to protect their businesses against sudden currency movements, potentially affecting their profitability on a transaction.
Through their bank or broker, they will use the futures markets to exchange their domestic currency with the counter-party’s currency at a favorable rate. Although the hedging transaction will cost money, it protects the importer or exporter against a severe plunge in their currency’s value.