DIVERSIFYING YOUR TRADING PORTFOLIO

When investing in the forex market, traders are taking calculated risks given that the value of the pair might go UP or DOWN. One way to manage the risk is learning about ASSET ALLOCATION and DIVERSIFICATION. Employing such strategies will enable traders to minimise their exposure as well as their capital at risk to any trade. As such, traders should invest time and energy in correctly planning their trades as well as their portfolio investments.

Asset allocation simply refers to how to distribute your available capital across trades. In simple terms - how many eggs go in the basket and which basket do they go in. The different baskets are called asset classes.

Three simple questions traders should ask themselves before making decisions are:

1. How comfortable are you with risk? (remember the 2% rule we looked at on our previous blog - what is money management)
2. What are your timeframes?
3. What is your current financial situation?

DIVERSIFICATION is about strategically mixing your trades within your portfolio to increase success potential. The KEY is that traders should invest their capital across different assets and not in one particular class.

For example, traders could choose to distribute their trades between

• STOCKS
• COMMODITIES
• CFD’s

Another way to diversify would be to:

1. Use the same trading strategy with different currency pairs
2. Use different trading strategies with the same currency pair

Ideally traders should want their investments to be NEGATIVELY correlated. That means that when one goes DOWN the other one goes UP. Without diversification you remain exposed to unnecessary risk.

But even when referring to diversification, there are several strategies traders could employ to diversify their portfolio.

Conservative approach

The conservative approach fits traders that are risk-averse and are interested in steadier income instead of exponential growth of their capital. It usually refers to short term investments.

Moderate approach

This approach focuses mostly on corporate bonds, government, alternative assets (e.g. gold). It is a strategy that is mostly employed and preferred to protect trader savings and helping them in the long term to stay ahead of inflation.

Balanced approach

The balanced approach is usually employed to evenly split the investments between income assets, alternative assets and global equities. It is employed by traders wishing to improve their portfolio diversification whilst (over time) increasing their savings.

Growth oriented approach

Investing mostly in global equities, whilst slightly diversifying with alternative and fixed income assets, this type of approach is usually employed by investors that are looking into a longer term investment with an increased risk appetite. The reason is that in longer period time frames, there are significantly higher chances to experience returns that are fluctuating.

Aggressive approach

Designed for traders with a high risk tolerance and longer horizon timeframes, this approach is used as a strategy to achieve longer-term capital growth. The reason this is a high risk strategy is that this approach has increased investment risk as there are significant chances to experience capital fluctuations. In this approach traders build their portfolios on equities with smaller exposure to alternative and fixed assets.

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This article / blog is for information purposes only and there are multiple techniques, in addition to those mentioned herein, which could be used. Readers may have different risk appetite and tolerance and therefore each reader should use their own and/or advisor’s judgement and guidance before proceeding further with the suitable technique.