Diversification is the distribution of your money that you invest across different financial cells. In simple words, it is a process of investing money on different instruments to minimize risks in cases of a failed transaction on one instrument (for example, currency) will lead to a reverse reaction on another transaction.
The definition itself means increasing diversity, expanding the range to increase efficiency. There are two types of diversification: connected and unrelated. The first type is to determine capital in financial instruments that are related to the everyday product, and unrelated – to determine capital in a new product that is not characteristic of this entity.
The Importance of Diversification for Trading
The Harry Markowitz Theory (is the Nobel laureate in economics) is important for diversification. The essence of this Theory is that weight and price depend not on one factor, but on the weight of the entire financial portfolio. The definition under this Theory is designed to reduce risk without reducing profits.
Traders on the contrary rarely use diversification. Of course, it reduces risks in the event of a failed deal. But also significantly reduces earnings. Traders who are used to earning “in a large way” do not divide their capital into different financial portfolios. And buy only one currency, of course the risk is very large, but as often happens – it is worth it.
For cautious traders who try a little, but steadily earn diversification – the best assistant. They use it all the time. But it should always be remembered that reducing the risk of determination reduces the amount of profit you will receive during the transaction. This applies not only to investments in different instruments, but, for example, to the division of money and the purchase/sale of them behind different strategies, rather than entering the market with all assets on the same strategy and waiting or disrupting the sale, or all losing.
Among the main rules that will help you enter the market and make profit are:
- Decide for yourself the size of financial assets which you are ready to bring into the foreign exchange market, it is not necessary to rely on excitement and to bring large sums;
- It is better to have accounts not with one broker, but with several verified brokers;
- Work with currency pairs, as they depend on each other and help you predict the movement of currencies;
- Trade different currencies on different strategies to minimize risk;
- If there is a crisis in the market, diversification will not help solve the problem, but if the market works normally, it is a good way to insure itself;
- Diversification is calculated by means of average earnings for each instrument (in our case – currency).
In conclusion, we note that diversification is a type of strategy that all traders use sooner or later. It is necessary to understand that trading on the stock exchange is not a game and it is necessary to take it with complete seriousness, it is best to acquire special knowledge on trading and to be able to apply them during transactions.