Hedging:

Hedging is the act of taking a position in the futures market which is exactly the opposite of one's position in other segments of the market such as the equity segment, with a view of offsetting losses in one segment (say, in equities)with a gain in the other (say, futures)

The rationale behind these acts lies on the fact that both segments of the market (Futures and equities) are moving in tandem and hence the loss on buying positions in equities could be eliminated or reduced to the minimum by taking a reverse position in the futures market. To elaborate, let us assume that one has a good equity portfolio of Rs.10 lakhs and he wants to hedge his portfolio against market falls. Simply speaking, he can do so by taking a sales position of Rs.10 lakhs or a little more in the futures segment.

Suppose that the market is falling in due course. It is no doubt that the investor would have lost on his portfolio. On the other side, he would have made a reasonable profit from the futures segment where he is a seller on the simple reason that he can settle the deal by purchasing futures contracts at a price lower than the one on which the sales were effected. Thus, the loss in equities are made up by the gain in futures as the market falls.