When you get started as a financial market trader, it’s advised that you focus your attention on a single market and select-few assets within this space.
While this is sound guidance (particularly when entering diverse marketplaces such as the foreign exchange), it also goes against the underlying importance of diversification within any successful investment portfolio.
But what exactly is diversification, and how can you look to successfully diversify your financial interests over time?
What is Diversification and Why is it Important?
The term ‘diversification’ is a relatively simple and self-explanatory one, which refers to a basic management strategy that blends different investments and asset classes within a single portfolio.
Utilised by fund managers and individual investors alike, it’s underpinned by the idea that a broad and carefully structured variety of investments will yield a noticeably higher return, while simultaneously minimising the risk and exposure associated with individual marketplaces.
Minimising exposure to a single stock, market or investment option is central to the appeal of diversification, as this can pose the biggest threat to your capital holdings over time.
This is because it fundamentally minimises the impact of a bad trade or outcome, especially when used in conjunction with stop loss measures available through platforms such as the MetaTrader 4 provided by Oanda.
Sure, this can also impact negatively on returns in some instances, the use of insight and data can ensure that it’s more likely to cut risk and enable you to cope in innately volatile markets.
So, although diversification does require you to trade profitability against risk in most instances, it ultimately optimises the risk-reward balance associated with your portfolio as it continues to evolve over time.
How to Successfully Diversify Your Investment Portfolio
As we’ve already touched upon, you’re best served by investing in a minimal number of stocks and markets when starting out.
However, you can still look to begin the process of diversification naturally as a new investor, before continuing to scale your efforts in line with profit and experience over time.
An excellent way to achieve this is to invest in derivative assets such as exchange traded funds (ETFs) or index funds, which effectively act as baskets of different stocks and instantly diversify your portfolio.
You can trade specific stock indexes through ETFs, for example, affording you access to specific groupings of assets that are categorised by factors such as industry and their country of origin (think of the Nasdaq 100 and Germany’s DAX30, for example).
When branching out, you should also target investments with variable risks and rates of return, with a view to ensuring that your portfolio is ideally balanced at any given time.
The key is to balance your risk-reward proposition in line with your outlook, while focusing slightly more on rates or return as a younger investor who can capitalise directly on compound returns.
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