Hedging

Diversification can and should be used by investors who want or need to take risk in the most efficient way. However, by definition almost, one can only diversify away unrewarded specific risk but not systematic risk, and even a well-diversified portfolio will experience severe losses in the worst market conditions. The proper risk management technique that should be used to ensure protection against systematic risks is not diversification – it is hedging. Just as diversification tells you how to be efficient when taking risks, hedging tells you how to be efficient when you avoid taking risks.