Should you do hedging?

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For many businesses and professional investors, hedging can be an important tool to help achieve their goals—particularly for those with the necessary resources (eg, employees with the skill and experience needed to understand and execute hedges). But it's important to know that hedging can be a double-edged sword—specifically, if the investment used to hedge loses value or negates the benefit of the underlying increase in value.

For individual investors, hedging may not be the best course of action—for several reasons:

      Complexity. Hedging typically involves advanced investment vehicles (relative to traditional investments, such as stocks and bonds). You need to fully understand the hedging instrument in order to consider using hedging. And even then, it may not be suitable.
      Cost . Hedging involves additional costs. Taking another position (such as buying options) involves a cost.
      Effectiveness. Hedging may not be effective, even if it is implemented as intended by the hedger. Consider the example of an airline that hedges the cost of airline jet fuel, only to have future jet fuel cost less after the hedge is implemented . Also consider an investor who buys a diversified mutual fund or ETF: If you believe that the components of the fund may be exposed to the risk of loss, you may not be able to easily hedge only those components of the fund.
      Suitability. Hedging may not make sense for long-term investors. For example, let's say you buy a stock with the intention of owning it for a long time (ie, more than a year). After a few months, you believe that the stock may be exposed to the risk of short-term losses. Hedging that risk exposure may not make sense, given the costs involved with hedging, if your intention is to hold the stock over the long term.

Consequently, you may want to manage your investments so that you have a diversified mix that aligns with your investment objectives and risk constraints. Diversification can help protect you against the idiosyncratic risks of individual stocks. While diversification does not guarantee against loss, it is probably the most effective risk management tool compared to hedging for most regular investors.