Hedging is a strategy often employed by investors and traders. Simply put, it works by investing in one entity to offset or “hedge” the risk of the other. For example, if an investor invests in a petrochemical company, they may offset the risk by additionally investing in a natural gas company which often trends in the opposite pattern of petrochemicals.
Offsetting Risks can be very useful
The strategy or practice of offsetting risks is indeed a very helpful one in many situations. Especially for a business that operated within industries that have higher risks involved, hedging can indeed be a tool that reduces the risks without always impairing the potential for profits.
How Can Hedging Work in Business?
There are certain ways in which businesses can use hedging. Some of these may already be used by businesses without being conscious of it being a hedging strategy. Sound hedging strategies include:
- Hedging through investments: Investing in other businesses that are likely to grow at a time when de-growth hits a business or investing in industries that often see growth when the industry of one’s own business faces challenging times.
- Hedging against raw material price changes: If certain commodities or input materials that a business uses in significant amounts, the business may hedge by investing in other materials of value, that tend to fluctuate in the opposite direction. For example, a company that uses precious metals can hedge on its raw material prices by investing in base metals.
- Locking in prices: Options, futures, and other such instruments of locking in prices are often a way to reduce risk. Hedging can be implemented by locking in prices of various periods of deliveries.
- Hedging services and products: Hedging services and products is something many small and mid-sized businesses tend to do. It’s simply done by offering services and products that tend to have roughly opposing trends. For example, a restaurant in a snowy region may hedge risks by offering home deliveries, so that on a snowy day, home deliveries can be focused upon while on a sunny day, walk-in customers may be the ideal customer.
Diversification is a Form of Hedging
The most common way in which businesses hedge risk is through diversification – catering to multiple sectors, industries, and a wide variety of customers, through a broader range of products and services is essentially a way to hedge risks.
Hedging Also Comes with its Risks
Like with any business strategy, there are risks associated with hedging even though it’s intended towards offsetting risk.
- Hedging must only be seen as a long-term strategy. It’s less likely to give short-term benefits.
- When you reduce risk, you often reduce the potential profits too. The risk then is to lose out on maximum potential.
- Hedging cannot guarantee less risk and is not fool-proof.
Financing Your Strategy
Hedging in itself is naturally a cost factor. If your business needs funds for hedging, a loan from Business Capital USA can help. Simply submit the required details and if your business meets our simple qualification terms, a loan offer shall be worked upon by our team.