Risk management is essential for better trading results
Diversification is generally known as one of the most common strategies to reduce risk to your portfolio. You diversify by holding assets that are not correlated with one another. This way, at least theoretically, assets do not all move in the same direction, and you do not suffer from big losses all at once. But despite the benefits, some analysts say that diversification is a regret maximization strategy, as it reduces profit along with the risk. Below we will teach you how to diversify your portfolio in the best ways possible.
Different approaches to diversifying your portfolio
There are many ways to diversify your portfolio. If you use Metatrader 4, then you have a valuable tool that helps you keep track of your exposure. You can do it easily with the exposure tool, which you can access from the tabs at the bottom of the platform. It will show you how your capital is allocated and where your biggest risk can come from.
Below we will discuss key ways to diversify your portfolio.
- Diversification across asset types. You can invest in forex pairs, shares, commodities, and other assets so that you do not put all of your money in one asset type. Shares tend to be less volatile to some extent than forex pairs, and thus this will probably reduce fluctuations in your portfolio. Many investors allocate 60 percent to shares, 20 percent to forex, and 20 percent to safe-havens. These percentages can and should change if the investment environment shifts.
- Diversification across sectors. This is common when you invest heavily in shares (or bonds, possibly). You can buy shares in different sectors like automotive, health, environment, agriculture, food, and staples, or others in order to have a balanced portfolio. Some of those sectors are defensive while others are not. As such, you can choose whether you want to build a conservative or aggressive portfolio.
- Diversification across geographies. Different countries can have different classifications. Some are high-income countries, while others are low-income ones. Some have advanced industrialized economies, while others are considered as emerging markets. The performance of different countries tends to show the disparity. Thus, it makes sense to diversify across countries or geographic areas (if you are more focused on economic clusters). This way, if China’s economy slows down, for example, your investments in Europe or the US may compensate for the losses.
- Diversification with cash. Some traders or investors choose to keep a part of their portfolio allocated in cash. This is not necessarily a bad strategy, as it enables you to have extra capital to use when new opportunities arise. In other words, this strategy is suitable if you want to have some liquidity. Despite this, senior investors usually warn against holding too much in cash since it can be exposed to inflation risk and currency risk, among others.
Summary
You can diversify your investments in various ways. However, you need to be sure that you are not doing it excessively or that it will negatively impact your performance. MT4 provides a useful tool that you can take advantage of for this purpose. It shows you your exposure and enables you to manage risk like a professional.
