Forex Trading – Strategy of Diversifying Portfolio to Avoid Risk
There’s no doubt that the global forex market is the most liquid entity of its type anywhere in the world, whilst an estimated $5.1 trillion is traded here every single day on average.
This market is also renowned for experiencing periods of volatility, however, whilst the margin-based nature of forex trading means that it’s always possible to lose more than your initial commitment.
It’s therefore crucial that you look to minimise your risk as a forex trader, and one of the best ways to achieve this is to create a considered diversification strategy. In this post, we’ll explore this notion further whilst asking what to consider when diversifying your portfolio.
What are the Benefits of Diversifying your Portfolio?
In simple terms, diversification is a technique that reduces risk by allocating investments across a vast array of asset classes and marketplaces.
So, whilst each individual investment must remain focused on optimising profitability, a considered diversification strategy will help to minimise losses across the board.
Of course, this type of strategy cannot overcome the undiversifiable and systematic market risks that underpin every financial market, but it’s certainly an effective way of minimising other risks that are within the control of a company or individual investor.
With these points in mind, the single biggest advantage of diversification is that it ensures that you don’t put all of your eggs into one basket. It’s also renowned as a source of hedging losses, which reduces the risk associated with an investment by taking offsetting positions simultaneously.
In short, diversification is a strategy that can have a positive impact right across the board, and the more uncorrelated your stocks are the better.
How to Diversify Successfully
With an understanding of diversification and its core advantages, the next step is to create a viable strategy that can optimise your chances of success.
This can be a challenging pastime, but here are some tips to help get you started!
- Access a Range of Markets Online: To start with, you should focus on building your knowledge base so that you’re able to diversify across different markets and asset classes. Platforms like Oanda can help in this respect, as they provide a wealth of trading insights whilst also enabling you to connect with different markets in real-time.
- Take a Detailed Approach to Organising your Assets: Stocks and currencies are likely to play a key role in any diverse portfolio, as each offers alternative risk portfolios and advantages. In the case of the former, you’ll need to be organised and selective when choosing your stocks, with conventional wisdom suggesting that 15 to 20 interests across different industries are capable of providing optimal diversification.
- Avoid the Risk of Over-diversification: The latter point is interesting, as it highlights the potential risk of over-diversification. This can cause you to spread your investments too thinly and leave you with minimal exposure to high-performance assets, creating a scenario where any returns gradually drain from your portfolio. This has much to do with the costs of holding investments, which can quickly mount as part of your diversification drive.