What is the definition of ‘hedging’ in finance?

Hedging is defined as a risk management strategy used in finance to offset potential losses in an investment by taking an opposite position in a related asset. This strategy is crucial for managing the risk associated with price fluctuations that could adversely impact an investment's value. By implementing hedging techniques, investors are able to protect their portfolios from unforeseen market movements, effectively mitigating potential losses that can occur due to volatility.

In contrast, maximizing profit on a single investment focuses solely on the upside potential without regard for potential risks, which is not the essence of hedging. Diversifying a portfolio aims to spread risk across multiple assets rather than directly protecting against losses in any one position, thus not capturing the proactive nature of hedging. Lastly, increasing leverage in investments involves using borrowed funds to amplify returns, which inherently increases risk rather than offsetting it, positioning it apart from the fundamental goals of hedging.