Risk Diversification for Retail CFD Traders

Best Binary Options Brokers 2020:
  • BINARIUM
    BINARIUM

    Best Binary Options Broker 2020!
    Ideal for beginners!
    Free Demo Account + Free Trading Education!
    Get a Sign-up Bonus:

  • BINOMO
    BINOMO

    2nd place in the ranking!

Contents

Risk Diversification for Retail CFD Traders

As traders, we generally look at popular investors who managed to generate consistent returns over a long period of time. Even though the information they provide is surely appropriate for some investors, it may not be the case in every situation. In particular, risk diversification is one of the most debated issues and if you are a CFD trader, we’ll clarify a few things in our current article.

Building a portfolio?

Investors generally build a portfolio of assets and hold their position in the long run, adjusting them or hedging the risk each time an unexpected event occurs. That methodology is hard to apply for CFD trading, because of the overnight swap charged every single day. If you’re trading contracts with a positive swap, it can be done, must most of the time your broker will charge you the swap each day.

This means day trading and swing trading are the most suitable for CFD trading, making the investors’ diversification method inappropriate. You can’t build a long-term portfolio with CFDs, but instead, you can trade multiple assets in order to have broad risk exposure.

How many assets to trade?

And we reach our second point, related to the number of assets one should trade. The answer is different, depending on each trader’s experience. If you are a beginner, you should ideally stick to a single instrument and as you start to have results, gradually increase the number of assets. For experienced traders, monitoring more than 10-15 assets could turn out to be overwhelming.

Our advice is to focus on a shortlist of instruments and constantly trade them, no matter what happens with the market. The reason is very simple: each instrument is unique, and the price is influenced by a different set of variables. As you get accustomed to them, it will be easier to spot trading opportunities.

Different trading strategies

Do you trade breakout strategies, short squeeze situations, false breakouts, use indicators like MACD or moving averages? Most of the traders use more than one strategy and that could have both positive and negative influences. On one side, different trading ideas will provide trade diversification, but on the other, it will be harder to analyze and monitor the risk.

You should study your trading analytics for each trading strategy individually, in order to see how each performs over a given period. It gets even harder when you have different strategies and plenty of instruments, the main reason why we advise to focus on a shortlist of trading instruments.

Risks With Contracts for Differences (CFD)

In finance, contracts for differences (CFDs) – arrangements made in a futures contract whereby differences in settlement are made through cash payments, rather than by the delivery of physical goods or securities – are categorized as leveraged products. This means that with a small initial investment, there is potential for returns equivalent to that of the underlying market or asset. Instinctively, this would be an obvious investment for any trader. Unfortunately, margin trades can not only magnify profits but losses as well. The apparent advantages of CFD trading often mask the associated risks. Types of risk that are often overlooked are counterparty risk, market risk, client money risk, and liquidity risk.

Best Binary Options Brokers 2020:
  • BINARIUM
    BINARIUM

    Best Binary Options Broker 2020!
    Ideal for beginners!
    Free Demo Account + Free Trading Education!
    Get a Sign-up Bonus:

  • BINOMO
    BINOMO

    2nd place in the ranking!

Counterparty Risk

The counterparty is the company which provides the asset in a financial transaction. When buying or selling a CFD, the only asset being traded is the contract issued by the CFD provider. This exposes the trader to the provider’s other counterparties, including other clients the CFD provider conducts business with. The associated risk is that the counterparty fails to fulfill its financial obligations. If the provider is unable to meet these obligations, then the value of the underlying asset is no longer relevant.

Market Risk

Contract for differences are derivative assets that a trader uses to speculate on the movement of underlying assets, like stock. If one believes the underlying asset will rise, the investor will choose a long position. Conversely, investors will chose a short position if they believe the value of the asset will fall. You hope that the value of the underlying asset will move in the direction most favorable to you. In reality, even the most educated investors can be proven wrong. Unexpected information, changes in market conditions and government policy can result in quick changes. Due to the nature of CFDs, small changes may have a big impact on returns. An unfavorable effect on the value of the underlying asset may cause the provider to demand a second margin payment. If margin calls can’t be met, the provider may close your position or you may have to sell at a loss.

Client Money Risk

In countries where CFDs are legal, there are client money protection laws to protect the investor from potentially harmful practices of CFD providers. By law, money transferred to the CFD provider must be segregated from the provider’s money in order to prevent providers from hedging their own investments. However, the law may not prohibit the client’s money from being pooled into one or more accounts. When a contract is agreed upon, the provider withdraws an initial margin and has the right to request further margins from the pooled account. If the other clients in the pooled account fail to meet margin calls, the CFD provider has the right to draft from the pooled account with potential to affect returns.

Liquidity Risks and Gapping

Market conditions effect many financial transactions and may increase the risk of losses. When there are not enough trades being made in the market for an underlying asset, your existing contract can become illiquid. At this point, a CFD provider can require additional margin payments or close contracts at inferior prices. Due to the fast-moving nature of financial markets, the price of a CFD can fall before your trade can be executed at a previously agreed-upon price, also known as gapping. This means the holder of an existing contract would be required to take less than optimal profits or cover any losses incurred by the CFD provider.

The Bottom Line

When trading CFDs, stop-loss orders can help mitigate the apparent risks. A guaranteed stop loss order, offered by some CFD providers, is a pre-determined price that, when met, automatically closes the contract.

Even so, even with a small initial fee and potential for large returns, CFD trading can result in illiquid assets and severe losses. When thinking about partaking in one of these types of investments, it is important to assess the risks associated with leveraged products. The resulting losses can often be greater than initially expected.

Asset Allocation: A Method For 2020

How to diversify the investment portfolio for 2020?

Before you start with asset allocation you have to choose what kind of investor you want to be. How do you see yourselves, like conservative, moderate or even aggressive investors?

For any investor, filling the investment portfolio with a proper mix of stocks, bonds, cash, real estate, and other investments is critical to financial well-being. This mix is known as “asset allocation.” The tricky part is that you cannot find a unique one that could suit all. Every investor must find own based on risk tolerance, timeline, and financial goals.

But even if you already defined what assets you want in your portfolio, it is still easy to get lost. Well, you want to optimize your portfolios, but you are gathering news every minute. And you are changing your decisions based on them. So, the consequence is that is more likely you have some “confused” portfolio, an assemblage of everything instead of a well-diversified portfolio.

Your portfolio has to be built with the goal of delivering income.

The asset management landscape is changing

First of all, In 2020 we can expect a huge rise in assets. It is predictable that economies in, let’s say, Asia, Middle East or Africa will grow faster than in areas with developed economies.

Extension in assets will be driven by several trends. One of them is the increase of wealthy individuals in those areas. So, we can expect the asset management landscape in 2020 will be changed. What investors have to do? Investors have to adjust their portfolios to new circumstances.

The investors should consider what caused an unusual change of growth and returns last year. Will the same conditions continue into this year? Will global economic growth returning to the trend? What about trade tensions? Is it over? All of this must influence investors’ decisions when building the investment portfolio and asset allocation.

The effect of asset allocation

The purpose of diversification is to avoid extremes. Asset allocation has to provide investors to score high returns, reduce volatility, protect them to have significantly lost capital.

You can accomplish this by asset allocation. All you have to do is to divide your investments into different classes of assets. Spread it into stocks, bonds, real estate, and cash. They will act separately from each other and your investment will be protected. Of course, you can spread your investment into cryptocurrencies, gold, commodities, or something else. Asset classes can be further divided into several sub-sectors.

Asset allocation is extremely important. Some studies reveal that asset allocation has a tremendous contribution to a portfolio’s overall returns. Even bigger than individual stock pick. Economists Paul Kaplan and Roger Ibbotson wrote that more than 90% of a portfolio’s long-term returns were generated by asset allocation. So, asset allocation has an important role in long-term returns.

How to start?

The first important step is to determine the target return. The issue is simply – by how much your portfolio has to grow to match your financial goals. But think about another issue too – what is your risk tolerance. How much risk are you able to take to gain a higher return?

You have to do all of this before choosing the investment strategy. If you are a buy-and-hold type you’ll be able to allow a higher level of risk. You will have periods with lower returns but they will be substituted with periods of higher-than-expected returns. So, it’s easy when you are an investor with a long horizon. But if you are not, if your time horizon is shorter, you’ll favor a lower risk portfolio.

Conservative Investing

Conservative investors tend to hold bonds. Their portfolios consist of 60%-80% in bonds of different maturity dates, different issuers. Well, bonds are not without risk, to be honest. Over the past few years, interest rates are rising and it causes bond prices to fall. The bond market can crash as well as the stock market. Do you remember 1979/1980? By some calculations, investors had losses more than $400 billion in total.

For example, baby boomers. They are inclining to conservative asset allocation. Their portfolios consist of over 70% in bonds. They control about 65% of all bond assets, by the way.

Modern asset allocation

There is something named modern portfolio theory and consequently, modern methods of asset allocation. This means a huge range of asset classes and sub-asset classes into portfolios.

At its core, modern portfolio theory is all about diversifying your asset allocation.

Modern portfolio theory is assumed to help reduce return risk by diversifying into many assets. But the first assumption of this theory is that asset classes are not in correlation. The point is to look at your investment as component parts of a whole. To be more clear, if one asset drops, the other will jump. It is just like a permanent zig-zag. Each investment is a moving gear. According to this theory, investors should balance a potential risk and returns but in the manner on how they might influence the risk and returns of the overall portfolio.

Start investing in 2020

Yes, you can do that, you can turn plans into dollars.

Just create portfolios to maximize the anticipated return based on an acceptable level of risk.

Don’t time the market. You have to look at your investment in the long term since the time in the market is very important. Do not let violent fluctuations or volatility disturb you. You are investing with your goal in mind.

Yes, you are more satisfied with less risk and nervous with grown risk. Moreover, you prefer the portfolio with the least risk, but one with the highest return possible and with the lowest risk.

Modern portfolio theory asserts that the risk for individual stock returns has two components: systematic and unsystematic risk. Systematic risk is the market risk and you cannot avoid it. For example, recessions, interest rates, wars are that kind of risk . The unsystematic risk is specific to individual stocks. Management changes, lessening the company’s operations, and similar, are unsystematic risks. You can lower this type of risk if you have a well-diversified portfolio and good asset allocation.

Proper portfolio building is difficult. It isn’t easy.

Asset allocation is portfolio diversification

The goal of asset allocation is to maximize the returns of a portfolio and reduce the risks.

Stocks will give you strong returns over a long time but they are volatile and inclined to periods ups and downs. But the combination of national and foreign stocks is healthy because sometimes one country is overvalued while another country is undervalued.

There are two main approaches to asset allocation.
Strategic Asset Allocation
Tactical Asset Allocation

Strategic asset allocation indicates holding a passive diversified portfolio. Meaning, you will not change your asset allocations based on market conditions. You will hold, add money and re-balance.

If you choose this strategy , you have to build a diversified portfolio of index funds or ETFs. From time to time you’ll re balance it. For example, when one asset class is increasing and another is decreasing in price. All you have to do in order to maintain the same weighting is to sell the increasing one and buy the underperformed assets.

Tactical asset allocation is complex and relates to almost permanent adjusting your weightings to different asset classes. You have to recognize where good risk/reward ratios are in the market.

The benefit is that you can really reduce volatility and increase returns. Though it’s more tending to individual failure, and if you do it badly you will decrease your returns.

Bottom line

Everyone would ask what’s the best asset allocation for a certain age? Here is one simple way to calculate it.

Subtract your age from 100 – that’s the percentage you should keep in stocks. For example, if you’re 40, you should hold 60% of your portfolio in stocks. If you’re 80, you should hold 40% of your portfolio in stocks.

But some advisors would recommend you to subtract your age from 110 or even 120 since people are living longer and longer.

When you choose what kind of investor you want to be whether conservative, moderate or even aggressive, it is time to focus on the asset allocation method. Spread it into allocations over particular investment categories: large, mid, small, and foreign stocks.

Balanced asset allocation in your portfolio is the right way to become a successful investor.

2 min read Asset allocation models are the way to split your investment in different…

3 min read The main asset classes are: a) Shares/stocks (also known as equities). b)…

Oracle is one of ten companies with the greatest cash in the US. Since its…

Diversification Is Important to Your Investment Portfolio

Your income is your greatest wealth-building tool, but not your only tool

When stock prices drop, bond prices increase. A portfolio that holds stocks and bonds plays better than the one that holds only stocks.

Diversification means to spread the risk across different types of investments. The main purpose of diversification is to enhance your chances of investment success. In other words, you are betting on every one.

Diversification is very important in investing because markets can be volatile and extremely unpredictable. If you diversify your portfolio, you will reduce the chance to lose more than you are prepared to.

And that is exactly what you would like in investing: to spread your capital among different assets. So you’re not relying on a single asset for all of your returns. The key advantage of diversification is that it provides you to minimize the risk of losing the capital invested.

What is diversification?

Diversification means building a portfolio of your investments in a way that the majority of the assets will have a different reaction to the same market performance. For example, when the economy is growing, stocks will outperform bonds. In opposite circumstances, bonds could play better than stocks. Hence, if you hold both stocks and bonds, you will reduce the risks in your portfolio from market swings.

Let’s make this more clear. What do you have in your pantry? Only beans? Of course not! When you went to the grocery you bought everything you need for the week or month ahead. The same should be with your investment portfolio. It should consist of various assets. But not too many. Too many assets mean you will not be able to follow their performances. If you are fresh in the stock market, maybe a two-fund portfolio is a good choice for you. More about this you can read HERE .

Think of these various types of groceries as the different areas, techniques, and areas available to you as an investor. If you have a variety of assets, you’ll be better protected. In the situation when one of your assets is hit by the risk you will still have the others that can give you a profit.

Reasons for diversification

Even the explanation is so simple you can still find so many investors that play on one card. You may ask how some really smart guys could avoid diversification and put all eggs in one basket? We couldn’t find the proper answer because the benefits are so obvious.

By diversification, investors lower the overall risk. It is logical how this works. When you spread your investments in various classes (diversifying them) you have more chances to avoid the negative influence in your portfolio. For example, let’s say you invested in stocks only and you hold a stock of just one company. Yes, we know you like it, it is a good company, famous, well-run. But if suddenly something unpleasant hit it and the stock price drops, let’s say, for 30%, how that occasion will influence your overall portfolio? You will lose 30% of your portfolio. But let’s consider the other situation. Let’s say that stock makes up a modest part of 5% in your portfolio. So, how much of your overall portfolio you will lose now? Can you see where is the benefit of diversification? It lowers the risk. Even during economic downturns, you will still have good players in your portfolio. Hence, if you have bonds and stocks added to your portfolio, it is more likely that even one of them will run well during particular circumstances. Bonds will play better when the economy is decreasing, but when the economy is growing, stocks will outperform bonds.

Diversification and investment strategy

You can find various investment strategies but two are most popular: growth and value investing.

Value investors tend to consider the strength of a company and its management. They would estimate if the company’s stock price is undervalued based on its true worth.

On the other side, growth investors would estimate how fast the company is growing, could its new products stimulate future earnings, etc.
By taking just one strategy you can miss out on the benefits of the other. But if you spread your investments on both of these strategies, it is pretty sure that you’ll be able to enjoy the benefits of each.

Influence of “home country bias”

Well, it is completely natural that investors are more attracted to their own state markets, the national industry. That’s how we come to the “home country bias” in investing. Of course, it is a natural tendency. But it can be a problem too. “Home country bias” can limit your investments to the offer from domestic markets. But what is needed for profitable and successful investing is to step out of your comfort zone. Foreign markets can be profitable also. What you have to do as an investor is to add some international fund or company to your portfolio. It is good protection and well-done diversification. Diversification across international markets will protect your investments if the domestic economy downturns (no one wants that, of course) or during the recession in your country. Several years ago we heard one of the investors saying it isn’t a patriotic gesture. Well, we have to say, investing isn’t an act of patriotism. It is all about profit.

Produces more opportunities

Eventually, diversification produces more opportunities if you make smart choices that deliver balance to your investment portfolio.

For example, you only invest in stocks. But suddenly some great opportunity occurs to invest in, for example, bonds. What will you do? Refuse to invest in bonds because you are not comfortable with them and risk to miss potential profit? We don’t think it is a smart idea. Never miss the opportunity to earn more, that isn’t in the nature of investing. Admit, you will never miss this opportunity to invest in bonds if you have a diversified portfolio. So, diversification gives you more opportunities to invest.

Protect and improve your finances

It is important to understand all the benefits of diversification. It isn’t hard to do. Actually, it is very simple. You have to read more, learn and be patient. If you diversify your investment portfolio you will have a chance to build stable finances over time.

How to diversify your portfolio

Firstly, never be too much invested. You will not be the winner if you own hundreds of assets. Okay, let’s say this way. Your portfolio is your team. And, as in every team, each part plays its role. No coach will put all players in one position. It’s stupid. Plus, how such a team will win anything? Of course, zero chances!

The point of diversifying is to hold investments that able to work separated tasks on your team.

Every single part of your portfolio should have a different role. For example, if you prefer stocks, diversify your portfolio to S&P 500 (that would provide you exposure to large-caps) and add some small-caps.

If you have a bond portfolio diversify it across short and long bonds, or higher-quality bonds, etc. That will reduce the risks. Or just add alternative investments in your portfolio. For example, private equity, hedge funds, real property, venture capital, commodities, etc.

Bottom line

How will you know you’re diversified? A well-diversified investment portfolio will never move in the same trend and at the same time. You must have one thing on your mind: you are the manager of your portfolio. Also, it is almost impossible for all investments to grow all the time. It is 100% sure that some of your positions will be lost, will lose you money. When that happens you will need the other holdings to balance that fall.

Diversification guards you against producing an undesired risk to your capital. Anyway, it is too risky to put all your money into one single investment. The key to diversification is to spread your money across asset classes and to allocate within classes. That is a smart approach.

2 min read How to structure your stock portfolio? The answer to that question depends…

5 min read There you are! You are a proud owner of crypto or stock…

2 min read Asset allocation models are the way to split your investment in different…

Risk Diversification in Forex

As the age-old adage goes, never keep all your eggs in one basket. In the same way, forex traders should look to diversify their trades, instead of putting all their money in one currency pair or trade. This is what increases the chances of survival, even during highly volatile markets. Diversification is a key element in managing risk in the forex market.

Risk diversification is a process that allows traders to mitigate the risk of huge losses in case the market suddenly moves downwards. Each currency pair entails a different market and the correlation between these markets offers sufficient scope for diversification.

Role of Correlation

Understanding the correlation between different currency pairs and even individual currencies is the most important factor in risk diversification. Correlations are complex in the forex market and can lead to overtrading and overexposure. Intra-market and inter-market correlations are common in this market.

How to Diversify

Here’s a look at some key things to consider when diversifying in the forex market.

1. Split Your Money

The first step in diversifying your portfolio is to divide your money. Traders may consider using the Pareto principle (80-20 split) for dividing their money. Pareto said that 20% actions lead to almost 80% of the effects. In risk diversification, 20% of one’s capital provides flexibility. Traders can figure out new trading strategies and have a buffer and free margin for recently entered trades with this amount. The remaining 80% can be invested in trading. This divides your trading account into cash and the money allocated for trading.

2. Consider the US Dollar

The US dollar is the world’s reserve currency and holds a key position in forex trading. It divides currency pairs into two parts: majors and cross pairs. Major pairs are the ones that have the US dollar as one of the currencies. For example, USD/CAD, GBP/USD and EUR/USD. CAD/JPY, EUR/GBP and NZD/CHF are examples of cross pairs. A trader may consider diversifying risk by investing in both major and cross pairs.

These two categories have different degrees of volatility, so trading strategies that need to be adopted for trading each type of pair will also vary. Major pairs trend more than cross pairs, so traders may consider dividing their money into 60-40, instead of 50-50, with a majority of the portion being allocated to major pairs.

3. Diversification Based on News Trading

Actively monitoring economic news or major world events can play a vital role in the decisions you make when to diversify your forex trading account. Traders may consider entering or exiting trading positions based on current events affecting the forex market.

For example, if any major announcement by the US government regarding its ties to China is due, a trader might consider only trading cross pairs or investing in just one or two major pairs, to avoid huge losses.

Tips for Diversification

Along with the strategy you adopt for risk diversification, you need to consider some things to capitalise on the potential of diversification.

1. Keep the portfolio small

While diversifying your forex trading account, consider investing in a small portfolio. This will help you better monitor the changes in the market and mitigate risks. Investing in two or three instruments may be considered by traders for risk diversification. For example, you can buy the GBP/JPY, sell the EUR/USD and sell the AUD/CAD. A small portfolio will also provide you time to analyse the market conditions, study fundamentals and other details related to trading.

2. Due Diligence

Due diligence, by analysing the fundamentals of a currency pair, is the first thing that should be done, before entering or exiting a position in a diversified portfolio. You may consider using an economic calendar and other sources of information for analysing the market. For example, if you intend to invest in the GBP, you should study and understand the economic factors affecting in the United Kingdom. Brexit is scheduled for March 29, 2020. Which deal is finalised for Brexit will impact the nation’s currency. You may also consider using technical analysis, along with fundamental analysis, to gain a better idea about whether to buy or sell a currency pair.

3. Managing a Diversified Account

The ultimate goal of risk diversification is to mitigate the losses due to unfavourable movements in the forex market. There can be times when all the pairs you own could lead to losses. In this situation, you need to actively track price movements to prevent getting a margin call from the broker. For this, you could consider calculating your risk exposure and placing stop losses at appropriate positions to prevent further losses.

4. Lot Size

Using smaller lot sizes can help reduce risks too. Larger lot sizes mean higher exposure, which in turn means both higher returns and higher losses.

5. Changing Trades

You may consider exiting a position after you have achieved your target. Sticking to a trade beyond the take profit level could lead to losses. Generally, the highest returns are generated by a single currency pair. But, during times of high volatility and uncertainty, you may consider placing two trades that aren’t correlated to reduce the risk of overall loss.

Inter-Market Correlations

Inter-market correlations are also a part of risk diversification in the forex market.

1. Oil and CAD pairs

The price of oil and the Canadian dollar are directly correlated. This means that oil prices will rarely fall if the price of CAD is rising, except when the Canadian central bank changes its monetary policy.

2. Gold and the AUD/USD

Globally, gold is generally priced in USD. Gold (XAU/USD) and AUD/USD are highly correlated due to the influence of gold mining on the GDP of Australia.

3. JPY and the US Stock Market

The Japanese yen has a very low interest rate and is the most desired currency for borrowing. Traders usually borrow in yen, convert it into USD and then buy in the US stock market.

Risk diversification is highly dependent on correlations and is one of the most effective strategies to adopt while investing in the most liquid market in the world. Improper understanding of correlations may lead to over-diversification. Traders who are able to figure out the right balance will have an edge when trading forex.

Best Binary Options Brokers 2020:
  • BINARIUM
    BINARIUM

    Best Binary Options Broker 2020!
    Ideal for beginners!
    Free Demo Account + Free Trading Education!
    Get a Sign-up Bonus:

  • BINOMO
    BINOMO

    2nd place in the ranking!

Like this post? Please share to your friends:
All About Binary Options Trading
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: