There are many ways to hedge, and for many different reasons. Lets say I want to invest in Home Depot because I think a lot of people are going to start building new houses and renovating their old ones. That means that lumber, construction companies, and other house things like appliances and nifty faucets should have a greater demand.

But what if I am wrong?

I don’t want to bet the farm, yolo and lose my investment. I haven’t done any analysis of Home Depot vs Lowes, but lets say from your analysis you have determined that Home Depot performs better in the market and overall is a much better and more profitable company than Lowes. You can buy 100 shares of Home Depot and simultaneously sell 100 shares of Lowes. If you are right and the real estate market goes up, you make money, but less than you would if you did not hedge. If you are totally wrong and the whole real estate market tanks, you lose money on your Home depot trade but because both stocks are tanking, you are making more money on your Lowes trade than you are losing on your Home Depot trade. So you are dead wrong on your gamble but you still make money.

Another way to hedge this trade would be to buy 100 shares of Home Depot and then buy an option to sell 100 shares of Home depot at the same price. This is like buying insurance, but prevents you losing more than the cost of buying the option. If you are right and home depot goes higher, the cost of the option cuts into your profits, but you are in a still profitable trade with less downside risk. If you are wrong you lose only the cost of the option.

There are a lot more techniques than this, all of them have risks and you can be wrong on all of them. Hedging can also take advantage of protecting against things that people dont think about very often, like your currency getting stronger or weaker against another currency, or interest rates or oil supply changing, or the sudden flooding of the market with Ten Forward Star Trek memes.