Hedging is opening a position that offsets the risk of another — deliberately reducing your exposure to an adverse move. Like insurance, it isn't free: you pay a premium or give up some upside in exchange for capping the downside (the protective put).

How it works

The classic example: you hold a stock you don't want to sell but fear a drop, so you buy a put — if the stock falls, the put gains, offsetting the loss (puts). Other hedges: shorting a correlated instrument, buying inverse exposure, or using index options to protect a whole book against a market decline (beta and market risk).

The cost of protection

Every hedge has a cost — the option premium you pay, or the upside you forfeit by holding an offsetting position (option decay). Over-hedging quietly bleeds returns: if you hedge everything all the time, you pay for insurance you rarely need and cap the gains that pay for the losses (you're buying insurance others sell). Hedging is a tool for specific risks, not a blanket.

A hedge is insurance, and insurance always costs something. The skill isn't hedging more — it's hedging the risks that actually matter, when they matter.

When it makes sense

Hedge when you have a concentrated or outsized exposure, an event you're worried about (earnings, a macro print), or a position you can't or don't want to exit (trading around earnings). For a defined-risk, right-sized trading approach, the "hedge" is often just smaller size and a stop — cheaper and simpler than a formal hedge (position sizing, stop-loss orders).