Which practice is used to reduce financial risk in trading or investing?

• A. Insurance
• B. Diversification
• C. Speculation
• D. Hedging

Answer: (D)

Hedging uses offsetting positions to limit potential losses from adverse price moves in trading or investing. For example, if you own shares and worry about a drop in price, you might buy put options or sell futures to cap downside while preserving some upside. Currency or interest-rate risk can be reduced with forward contracts or hedging swaps, stabilizing cash flows regardless of market moves. Diversification spreads risk across assets, which lowers overall volatility, but hedging targets a specific exposure and directly limits potential losses. Insurance pertains to transferring certain risks to a third party, not a market strategy to control price moves in portfolios, and speculation is about taking on risk rather than reducing it. In short, hedging is the practice designed to actively reduce financial risk in trading or investing.