When it comes to short selling in the stock market there are two general forms this activity takes. The first is called “Speculation.” The idea behind this strategy is that you watch the fluctuations of the market in hopes of timing a high risk high profit short sell. Generally speculation is seen as a negative part of investing as it mirrors in many respect gambling. But, there is a degree of calculation and assessment involved such that the investor plans on making his move when his analysis indicates that the timing is right. The way that speculating differs most significantly from “hedging” is that with speculation the investor assumes all the risk without minimizing it, meaning if his calculations are incorrect he stands to lose a great deal of money. Of course on the upside, should he have calculated correctly, he stands to make a great deal of money. But this is how high risk investments work.
“Hedging” is different and in many ways the opposite of speculation. By hedging you attempt to minimize the potential risk involved in investing. For example, let’s say you’ve heard of brand new soft drink company called Tango. You want to invest in Tango because you really like the product and think other will also. But, to hedge your bets you’re going to also purchase stock in Coca Cola, a proven company, but short sell it because you’re pretty sure that Tango will take away from Coke and their stock will drop. Should Tango go up and Coke lose stock value you will make money on both investments. But, if the soft drink industry as a whole goes up, meaning both Coke and Tango’s stock increase then you make money on the Tango and take a hit on Coke, but hopefully come out with a modest gain overall. If the opposite is true, and another product hits the market and drives the stock in both Coke and Tango down, then you will lose money on Tango, make money on Coke and hopefully still come out with a modest gain. Hedging leaves you with a possible gain no matter which direction the market goes and therefore there is less risk, but the gains are also less substantial.