Concept
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A second form of risk mitigation is loss prevention and reduction, in which risk is accepted while steps are taken to minimize the potential loss. Hedging is a popular and well-known example. It is a technique whereby the participant (or an agent acting on their behalf)will take the opposite position of their trade (known as an inversely correlated position). In this way, risk is mitigated as they stand to gain from either outcome, albeit to varying degrees.
Suppose you run a transport business. Fuel is therefore one of your largest expenses. You have heard that there are going to be cuts in the global supply of oil, which means the price of oil, and therefore fuel, is likely to increase in the coming months. This increase in expenses would harm your profit margin, so you decide to hedge your risk through a futures or forward contract which allows you to buy oil at a predetermined price at a date in the future.
Let us assume oil is priced at $50 per barrel. You buy oil, for delivery in six months, through a futures contract at a $60 per barrel future price, and six months later the oil price is $70 per barrel. You have offset your price risk by $10 per barrel ($70 -$60 = $10). In doing so you have essentially paid $10 less by buying oil ahead of time. Note, however that this saving is not strictly $10, since there may be costs associated with holding the asset until you need it.