Series 7 Practice Exam 2025 – Complete Preparation Guide

Hedging an investment involves taking an opposing position in a related security to mitigate the risk associated with price movements. This strategy aims to protect an investment from potential losses by offsetting adverse price swings.

For example, if an investor holds a stock that they expect might decline in value, they could purchase a put option on that stock. This way, if the stock's price does fall, the losses on the stock are offset by gains on the put option. Therefore, hedging helps manage risk and can preserve capital.

Understanding the concept of hedging is crucial for investors who want to manage their exposure to volatility and protect their portfolios from unfavorable market conditions. While adjusting a portfolio in response to market trends or selling off underperforming assets are important strategies, those actions do not specifically focus on reducing risk in the same direct way that hedging does. Additionally, increasing exposure to risk for greater potential return is counter to the principle of hedging, which aims to minimize risk.