is hedging really risky? what are the ways of hedging risk?

Hi Dinesh, Hedging itself meant/used to reduce the risk, it is not a risky. But you should be knowing the practicle knowledge as how to use it effectively.

Before going to the ways of hedging risk, let me tell you what is hedging.

"Hedging is a strategy to reduce or avoid investment or any business risks prevailing in the market".

There are many ways we can use this hedging strategy. They are:

1) Everyday Hedges: Most people have, whether they know it or not, engaged in hedging. For example, when you take out insurance to minimize the risk that an injury will erase your income, or you buy life insurance to support your family in the case of your death, this is a hedge. You pay money in monthly sums for the coverage provided by an insurance company. Although the textbook definition of hedging is an investment taken out to limit the risk of another investment, insurance is an example of a real-world hedge.

2) Hedging by the Book: Imagine that you want to invest in the budding industry of bungee cord manufacturing. You know of a company called Plummet that is revolutionizing the materials and designs to make cords that are twice as good as its nearest competitor, Drop, so you think that Plummet's share value will rise over the next month.

Unfortunately, the bungee cord manufacturing industry is always susceptible to sudden changes in regulations and safety standards, meaning it is quite volatile. This is called industry risk. Despite this, you believe in this company and you just want to find a way to reduce the industry risk. In this case, you are going to hedge by going long on Plummet while shorting its competitor, Drop. The value of the shares involved will be $1,000 for each company.

If the industry as a whole goes up, you make a profit on Plummet, but lose on Drop - hopefully for a modest overall gain. If the industry takes a hit, for example if someone dies bungee jumping, you lose money on Plummet but make money on Drop.

Basically, your overall profit, the profit from going long on Plummet, is minimized in favor of less industry risk. This is sometimes called a pairs trade and it helps investors gain a foothold in volatile industries or find companies in sectors that have some kind of systematic risk.

3) Edging by other way: Hedging has grown to encompass all areas of finance and business. For example, a corporation may choose to build a factory in another country that it exports its product to in order to hedge against currency risk. An investor can hedge his or her long position with put options or a short seller can hedge a position though call options. Futures contracts and other derivatives can be hedged with synthetic instruments.

Basically, every investment has some form of a hedge. Besides protecting an investor from various types of risk, it is believed that hedging makes the market run more efficiently.

One clear example of this is when an investor purchases put options on a stock to minimize downside risk. Suppose that an investor has 100 shares in a company and that the company's stock has made a strong move from $25 to $50 over the last year. The investor still likes the stock and its prospects looking forward but is concerned about the correction that could accompany such a strong move.

Instead of selling the shares, the investor can buy a single put option, which gives him or her the right to sell 100 shares of the company at the exercise price before the expiry date. If the investor buys the put option with an exercise price of $50 and an expiry day three months in the future, he or she will be able to guarantee a sale price of $50 no matter what happens to the stock over the next three months. The investor simply pays the option premium, which essentially provides some insurance from downside risk.

It depends on how you define your business. If you are hedging risks associated to your physicals and you expect to make or break your organization in the respective physical trade, then hedging is a very effective tool to to effectively manage various risks. However if you are a punt player, then hedge or no hedge you have equal risk over an extended period of time.

I think the core problem when deciding upon a hedging  is to strike a balance between uncertainty and the risk of opportunity loss. So it is risky, the success or failure of which can make or break a firm.