Sometimes you hear the word “Hedge”, such as “Hedge Fund”, “Safe-Haven Currency”, “Safe-Haven Asset”, “Hedge Tools”, etc. But what exactly does hedging mean? Let’s find out now!
What does Hedging mean?
Hedging means: protecting profits & reducing risks
This is the same concept as buying insurance. Like accident insurance, we don’t want accidents, but no one can guarantee the future. Therefore, when an accident occurs, we will be lucky to have insurance, because we can get claims from the insurance company and reduce the financial burden. The most special part about insurance is about the”pays less and receives more.” If it is net life insurance, we only need to pay a few dollar a year, but the beneficiary may receive one million when the person really dies. The same is true of many hadging in investing.
What are the safe-haven assets?
Gold, Treasuries, etc. are called “safe haven assets” because they usually rise when the stock market falls. Gold has been a symbol of cultural luxury in various countries since ancient times, and it is physical, not easy to be damaged. Therefore, when an economic storm comes, people tend to buy gold and let it rise.
Bonds are issued by the government. Since they are issued by the government, the probability of default is very low. Therefore, it is so similar to gold, when the economic turmoil hits, people will snap up Bonds, then there will be a bullish trend.
What are the safe-haven currencies?
The so-called “safe-haven currency” is “the currency that can avoid risks”. Currency is a tool for buying and selling things within a country. To avoid risks, the country’s political situation and economy must be stable, and its liquidity should be good. There should no problem of “can buy but can’t sell”. These conditions will change with the current situations, and the safe-haven currencies will also change with the current situations. The current safe-haven currencies are “US dollar, Japanese yen, euro, Swiss franc” four currencies.
US dollar: Needless to say, the world’s largest power and the most circulating currency in the world is of course a safe-haven currency.
Japanese Yen: Representative of Asia. Japan’s long-term low interest rates have allowed countries around the world to borrow money from Japan to invest when economy prosperity and repay Japan when economy slump. Therefore, the yen tends to rise when the economy is slump. Although Japan’s economic strength is not as good as that of China, the liquidity of the yen is much better than that of the RMB, so the yen is more likely to be used as a safe-haven currency.
Euro: A global power – the currency in circulation in the EU, but in recent years, due to the financial difficulties of several countries in the EU, the status of the euro as a safe-haven currency is slightly controversial.
Swiss Franc (CHF for short): Switzerland is a “permanently neutral country “. First, because it is located in the Alps, the terrain is easy to defend and difficult to attack; secondly, because the Swiss Bank hides the secrets of dignitaries from all over the world, anyone who attacks it will ask for trouble; The above three factors allowed countries around the world to recognize its neutrality, and also allowed Switzerland to escape from World War I and World War II, with a very low risk of war. Coupled with its stable social environment, the Swiss franc has also become a well-known safe-haven currency.
The above are “safe-haven assets”, in addition to “hedging tools”.
What are the hedging tools? What are the ways?
In addition to the above-mentioned safe-haven assets, hedging tools also include highly leveraged derivatives such as futures and options, and they are used in different ways.
A simpler way is the concept of asset allocation such as “a part to buy stocks, a part to buy gold or government bonds “. For example, if I have 1 million, I buy stocks with 500,000, bonds with 300,000, and gold with 200,000. In this way, when the stock market crash comes, the stock of 500,000 may drop by 10%, leaving 450,000, and the government bonds and gold may each increase by 5%, becoming 525,000, so the entire 1 million will only lose 25,000, which is more than the entire 1 million. It’s much better to buy stocks and lose 100,000.
On the other hand, high-leverage commodities can use a small amount of money to obtain hedging effects, such as options. The leverage of the option is generally around 40 to 60 times, and there is even a probability of 100 times or 200 times.
Although the concept of option hedging sounds simple, it is much more difficult in practice. For example, the option also has the issue of the expiration date. If the stock market does not fall before the expiration, the 2,000 yuan will also disappear; if the stock market does not fall but rises, the option will also eat up the profits of the stock and so on. This requires a deeper professional. Therefore, if you feel complicated about this, you might as well simply allocate some funds to buy safe-haven assets such as gold and government bonds.
What is the difference between a hedge fund and a mutual fund?
Another term that is often heard is “hedge fund”. It’s easy to misunderstand the word hedge fund and think it “avoids all risk”, but that’s wrong. It is called a “hedge fund” because it has less regulation than other funds (such as mutual funds, annuity funds, etc.) and has more ways to use the above-mentioned hedging tools. So, if mutual funds fall 50% during a financial turmoil, hedge funds may fall a little less.
But not every hedge fund is so good, it depends on the skill of the investor. Besides, the investment threshold of hedge funds is high and the information is more closed. Therefore, if you have the opportunity to invest in hedge funds, you must check with multiple parties.
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Disclaimer: Information above can only be use for references and doesn’t represent our platform’s opinions.