In finance, a hedge is a position established in one market in an attempt to offset exposure to price fluctuations in some opposite position in another market with the goal of minimizing one's exposure to unwanted risk. There are many specific financial vehicles to accomplish this, including insurance policies, forward contracts, swaps, options, many types of over-the-counter and derivative products, and perhaps most popularly, futures contracts. Public futures markets were established in the 1800s to allow transparent, standardized, and efficient hedging of agricultural commodity prices; they have since expanded to include futures contracts for hedging the values of energy, precious metals, foreign currency, and interest rate fluctuations.
A typical hedger might be a commercial farmer. The market values of wheat and other crops fluctuate constantly as supply and demand for them vary, with occasional large moves in either direction. Based on current prices and forecast levels at harvest time, the farmer might decide that planting wheat is a good idea one season, but the forecast prices are only that - forecasts. Once the farmer plants wheat, he is committed to it for an entire growing season. If the actual price of wheat rises a lot between planting and harvest, the farmer stands to make a lot of unexpected money, but if the actual price drops by harvest time, he could be ruined.
If the farmer sells a number of wheat futures contracts equivalent to his crop size at planting time, he effectively locks in the price of wheat at that time - the contract is an agreement to deliver a certain number of bushels of wheat on a certain date in the future for a certain fixed price. He has hedged his exposure to wheat prices; he no longer cares whether the current price rises or falls, because he is guaranteed a price by the contract. He no longer needs to worry about being ruined by a low wheat price at harvest time, but he also gives up the chance at making extra money from a high wheat price at harvest times.
