A:

Cross hedging is when you hedge a position by investing in two positively correlated securities or securities that have similar price movements. The investor takes opposing positions in each investment in an attempt to reduce the risk of holding just one of the securities. The success of cross-hedging depends completely on how strongly correlated the instrument being hedged is with the instrument underlying the derivatives contract. When cross hedging, the maturity of the two securities has to be equal. In other words, you cannot hedge a long-term instrument with a short-term security. Both financial instruments have to have the same maturity.

Hedging is a form of investment insurance that is meant to reduce risk. Hedging does not eliminate the amount of risk involved in an investment; it just softens the negative effect on the hedger. Typically, hedging involves investing in two securities that have a negative correlation. A negative correlation means that the two securities move in opposite directions. When one security looses value, the other gains value.

For example, you could have a long position in a gold company then take a short position in a gold ETF. Because the price of the gold company's stock would move in tandem with the price of gold, it would create a cross hedge. There wouldn't be a perfect correlation, so this example would not provide a perfect hedge.

RELATED FAQS
  1. What happens if you don't hedge your investments?

    Learn the purpose, advantages and disadvantages of hedging, and find out how to utilize hedging to enhance an overall investment ... Read Answer >>
  2. Is it possible to be perfectly hedged against risk?

    Learn what it means to mitigate the market risk of a portfolio through hedging and to what extent hedging can reduce downside ... Read Answer >>
  3. What does a hedge fund do?

    Read how hedge funds differ from other investment vehicles and how their investment strategies make them unique and potentially ... Read Answer >>
  4. What is the purpose of a hedge fund?

    Find out what a hedge fund is, how it is set up and why it is different than other forms of investment partnerships like ... Read Answer >>
  5. What is the difference between hedging and speculation?

    Hedging involves taking an offsetting position in a derivative in order to balance any gains and losses to the underlying ... Read Answer >>
Related Articles
  1. Trading

    A Beginner's Guide to Hedging

    Learn how investors use strategies to reduce the impact of negative events on investments.
  2. Investing

    Hedging Risk for Beginners: How and When to Do It

    Hedging risk is always a good idea. Here is how sophisticated investors go about it.
  3. Trading

    Hedging Basics: What Is A Hedge?

    This strategy is widely misunderstood, but it's not as complicated as you may think.
  4. Investing

    Hedging for Beginners: A Guide

    People hedge as insurance against market volatility. Anyone can do it; here's a primer.
  5. Managing Wealth

    Will Hedge Funds Be Around in 10 Years?

    Learn why some analysts see hedge funds as a dying breed, especially after a torturous January 2016 for fund managers around the world.
  6. Investing

    Taking A Look Behind Hedge Funds

    Hedge funds can draw returns well above the market average even in a weak economy. Learn about the risks.
  7. Financial Advisor

    Why Hedge Funds Are Not Living Up to Return Hype

    Hedge funds are supposed to produce better returns while protecting your investments from the downside. Here's why they are not living up to their purpose.
  8. Investing

    Hedging With ETFs: A Cost-Effective Alternative

    The benefits of ETFs for hedging are clear and investors of all sizes are taking notice.
  9. Investing

    How To Start a Hedge Fund In the United States

    A general overview of how to start a hedge fund firm in the United States, including complying with state and federal regulations.
  10. Investing

    What Are Some Reasons to Invest in Hedge Funds Now?

    Financial news has been dominated in recent months by reports of hedge fund struggles. Are there any reasons why investors might consider hedge funds now?
RELATED TERMS
  1. Hedge

    Making an investment to reduce the risk of adverse price movements ...
  2. Downside Protection

    The use of an option or other hedging instrument in order to ...
  3. Hedge Ratio

    1. A ratio comparing the value of a position protected via a ...
  4. Hedge Fund Manager

    The individual who oversees and makes decisions about the investments ...
  5. Inflation Hedge

    An investment that is considered to provide protection against ...
  6. Basis Risk

    The risk that offsetting investments in a hedging strategy will ...
Hot Definitions
  1. Mobile Wallet

    Mobile wallet is a virtual wallet that stores payment card information on a mobile device.
  2. Leverage

    1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. ...
  3. Trumponomics

    Trumponomics is a term for the economic policies of President Donald Trump.
  4. Universal Health Care Coverage

    An organized healthcare system that provides healthcare benefits to all persons in a specified region. Many countries, such ...
  5. Davos World Economic Forum

    The annual meeting of the World Economic Forum hosted at Davos—a small ski town in Switzerland—in January each year is among ...
  6. Smart Home

    A convenient home setup where appliances and devices can be automatically controlled remotely from anywhere in the world ...
Trading Center