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Diversify your Investments Across Different Asset Classes

Written by Andy
  1. Be aware of the risk that you are exposed to – both on individual positions and in your investment portfolio as a whole. Don’t bet the farm on one or two large trades. Beginners tend to fall for this in an attempt to maximise their returns but most don’t realise that they are also taking big risks. In such situations if the trades go against you , you risk losing all your trading capital. Make no mistake – if you have most of your monies in the Juniors and penny stocks you are effectively gambling!
  2. Research has demonstrated that 90% of historical returns are attributable to being in the right asset class as opposed to a particular share at exactly the right time.
  3. Maintain a healthy portfolio balance. No more than 10 percent of your portfolio should be on any one stock, and no more thann 25 percent of your portfolio should be in any one sector. Plus, the maximum you should allow to put in AIM/Small Caps/Juniors should be just about 10 percent. Speculative shares should be kept to around three or four stocks of a 10-stock portfolio.
  4. Shocks are obviously one thing that cannot be predicted, so the best course of action is to always try to have at least a marginally hedged position wherever possible and this is a big advantage of having a diversified portfolio. That said, you can’t just hedge for the sake of hedging and there has to be a reason to enter any market, either on the long or the short side.
  5. Diversification is key here. Spread your investments across different asset classes such as commodities, property, shares, foreign exchange, timber, infrastructure and even hedge funds. In a nutshell; don’t just go for bonds and shares. Think globally and laterally. Passive ETFs are a good tool in this respect and very good cost-effective. A well-diversified portfolio of different shares and markets lowers the volatility and thus reduces the overall risk exposure. The less correlated the returns, the greater the diversification.
  6. Hold both long and short CFD trading positions to further minimise risk. CFD traders have an advantage over share traders in that they are able to hold a combination of long and short CFD trades. Holding both long and short positions introduces a negative correlation since when the market is rallying, your long trades would likely go up in value (whereas the shorts would incur a loss) which considerably reduces the overall account risk. If the net exposure of long and short trades are equal (and opposite), then the portfolio will effectively be market neutral and directed exclusively by the share-specific returns.
  7. The most consuming of all pain with contracts for differences is if you buy and the stock keeps falling (that’s why you need stop losses in place!) If you buy shares in different companies in uncorrelated industries, this should not happen to all your trades, and if it does you might have to re-examine your selection criteria. Unless of course the whole market tanks – and I’ve been though that experience and you then have to exit taking the punishment like a man. Although rare, it can and does happen.
  8. Make sure you have sufficient trading capital and take small risks. This will allow you to trade profitably over the long term.
  9. The sensible use of a suitable position sizing strategy will also help you to avoid the common mistake of placing all of your eggs in the one basket. Nearly every trader recognises the high risk of placing all your funds in a single investment yet people continue falling for this basic mistake. This is all about managing risk. This is where most traders and investors gets it so wrong, they don’t know how to manage risk at all.
  10. Having said all that do appreciate that diversification does not seek to manage risk, but to eliminate it. Keep in mind that there can be no gain in the absence of risk. The greater risk you take, the higher the returns you can make, and also the higher the losses you face if your risk is not well managed. But even so risk has to be present. If your portfolio is too heavily diversified whatever returns you make on one asset may end up being offset by losses on another, and any losses you incur in one asset do not result in wipeout because of gains in other assets – at the end your portfolio won’t perform too well but neither will it do badly, it is just very well hedged.

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