How do you diversify?

JohnsMoneyTree

Active Member
Forex traders are a special bunch, especially new traders. We often get caught up in technical indicators, trend spotting, candlestick pattern analysis and news events. To be successful, we often think, means being aware of every financial news source and chart all the time!

After a few months of this, people start burning out and swear off trading the Forex completely. Those of us who stick it out either learned that we don't need to micro-manage every trade (unless we're scalping of course) and we often go to larger time frames such as H1 or H4 from the M5 that we may have started with.

But diversification is something that we don't always consider outside of our trades. If you ask a Forex trader about their diversification strategy you'll often get a response like: "Diversify? Sure, I trade EUR/USD, GBP/USD and USD/JPY! I diversify across three currency pairs!" That's not quite what I meant.

When you trade, do you set a stop loss for every order? I expect the majority of you do. Forex trading is definitely a high risk form of investing and we often set stop losses to protect ourselves from wiping out our accounts. Yet when I hear of traders solely focused on Forex trading for the financial future I have to ask why? Being successful in Forex trading is great, but the returns can be highly variable. What do you do with your Forex trading profits? Store them in a mattress, bury them in a mutual fund? Buy and sell stocks on the side?

We know that the majority of people who try their hand at Forex trading lose their initial investment and then swear off trading completely. For those that remain, very few people make it to the point that they quit their jobs and try to live off of Forex trading completely as their sole source of income. For the majority of day traders, it is easy to get blinded by the allure of Forex trading. The hope is that you can "strike it rich", be one of the "super elite" and quit your day job to trade Forex full time. Unfortunately reality doesn't always meet our dreams, but we still chase them without paying attention to the risks. Just like setting a stop loss for your Forex orders, why not set a stop loss for your investments?

The phrase "putting all your eggs into one basket" is usually thrown around when people start talking about diversification, but nobody ever really defines what the "eggs" and "basket" are! I think everyone can agree that the "eggs" are money, but the "basket" is where things get fuzzy. When a Forex trader says that they trade a handful of pairs and that's how they diversify, well, they still have all their money tied up in a high risk investment, namely Forex trading! Likewise for stock traders who trade a variety of different sectors, they are still trading stocks which is also a high risk investment!

The whole point of diversification is to make sure you protect as much of your investment capital as possible. You don't want to have everything (or the majority) of your investments tied up in one type of investment. You want a balance of liquidity, security, growth and (whenever possible) protections against substantial loss. You also want a decent ROI, but that goes without saying.

I personally trade the Forex and have it account for about 35% of my overall investment portfolio. I love the Forex and the excitement that surrounds it. It's unlike any other investment option out there, with great potential for both gains and losses. At the same time I love my family and know that not only do I want to continue to provide for them now but also for the long term future. The markets are fickle and there's always risk when trading the Forex, so I choose to diversify in other options like bonds, stocks and even a little cash that grows at a glacial pace.

Just remember there's more out there than just Forex, even if she is a seductive temptress.



I'm the author of "Growing The Money Tree", a book aimed at new Forex traders, people seeking financial independence and those curious as to why I want to work as a Barista at my local Starbucks. For more on my ramblings, check out my blog at http://www.growingthemoneytree.com/blog/.
 

jack

Administrator
Staff member
shopster said:

Diversification is a retail investor myth, spewed out by the media drones and some idiot self promoting his online rag / blog.


trading is a hard core activity where you crawl your way to the top 5% by grinding it our for a few decades.

wade thru all the online bullshit, dial in your edge and keep pounding on it till you arrive.

investing is dead.
the stock jock game is played by the machines.
the edge is gone.

the hedgies are now trading among themselves and there is no ROI left.


when Stan decides to pack it in the game is over.

http://www.youtube.com/watch?v=4W58zLwdDzM

the bloomberg twit and pink tie guy have no clue.

spot trading is the best show in town.
centralized exchange owning this game will happen when hell freezes over.

the 6's trading at the merc is a clown act.

the bankster's own this game and will not give up control ever.

s
I respectfully disagree here. Mostly because I entirely compartmentalize 'trading' from 'investing'.

For me, 'trading' is an active income producing activity, while 'investing' is passive and stuff I want to buy once and not look at again for 5-10-20 years.

I also don't think OP's point was to diversify their 'trading' activity into stocks.. (you were talking about having no trading edge in stocks.) Instead, I think OP was just talking about dividing up investment capital for the long term, with a portion of it was "invested" in himself for trading forex and the rest "diversified" into other assets.

To make an analogy: OP isn't talking about a professional poker player learning Omaha on the side to pickup a new game, but a pro poker player making sure his bankroll isn't his entire net work and buying some long term bonds/gold/stocks on the side with the money he wants to stash away.

--

While I agree with you on the 6's over at CME, I don't agree that there's no edge in equities... that is, there's still edge to be found with the right trading conditions. Sadly, retail traders don't have access to such conditions, and as far as discount stock brokerage 'retail' level is concerned, the intra-day penny scalping game is long gone even with IB's prices. They gotta buy and hold over long enough periods that the algos don't matter..

And you're right, bankers own the spot game and don't want to give up what's profitable for them.. so we have that going for FX traders (that the market won't be turned on its head and restructured anytime soon.) Plus, it's impractical, since the whole reason why forex can operate as well functioning OTC global marketplace is that currency is fungible.. so we simply don't need an exchange to standardize contracts and get everyone trading the same specifications since in the end, it's just currency (or exposure to that currency) that can be moved and spent no matter how it's traded... easy to clear, easy to hedge, easy to transfer... etc..
 

jack

Administrator
Staff member
How I diversify?

I just mentioned in my previous post that I compartmentalize 'trading' from 'investing'.

I actually don't want to be wearing my 'trader' cap when I manage my personal investments. The two worlds do not need to intersect here. Instead, I take the 'lazy' investors approach and just index a set amount of funds every so often through razor thin MER index funds.

Shop mentioned that there's little ROI to be had with hedge funds eating each other's lunch.. and in a way he has a point: Most actively managed funds suck.. they cost a metric tonne in MER and sometimes even performance fees, while providing little performance increase over the index in the long run (and by 'long run' I mean 20-30 years.)

So instead of betting that some fund manager will out perform the index and overcome the high fee structure on the fund itself just to get me a point or two above the index over a 20 year period, which is statistically unlikely, I'll just buy the index itself and balance it against other asset classes like bonds.

It's actually kinda funny... I can't tell you how many times people find out I work at an equities firm as a trader and then they ask me "is Apple [or XYZ Corp] a good investment?" ...I have to explain that I don't know nor care if they are a good long term investment, and that I just index invest, and that the only time I care about "XYZ Corp" is intra-day and for a few pennies of price difference. Trading and investing.. different worlds.

EDIT: I will say that I do tend to keep some extra risk capital to trade long term.. but again, this is trading, not investing. I mean, I might toss a few bucks at some small company I believe in, or into digital currency as is the latest craze, just to see where it goes in a few years... but even if these are long term 'trades', my mind doesn't consider them 'investments' and I strictly limit how much of my 'trading capital' I'm willing to put into them.
 

JohnsMoneyTree

Active Member
shopster said:
trading is a hard core activity where you crawl your way to the top 5% by grinding it our for a few decades.

wade thru all the online bullshit, dial in your edge and keep pounding on it till you arrive.
I see you are the business man in the story of the fisherman and the business man.

I agree that trading is a hard core activity and that very, very few people are successful at it enough to use it to replace a steady income. As for myself, I would like to eventually retire so even with a healthy profit from trading I would like other passive forms of income to supplement my lifestyle.

To each their own my friend, if you choose the hard road and find success, then all the power to you. To those who try and risk losing everything because of such a narrow focus on a single form of investing, then take heed and try to at the very least look at alternatives to protect your assets.

shopster said:
investing is dead.
the stock jock game is played by the machines.
the edge is gone.
My only question to you is that if investing is dead, then what is Forex trading if not a very short-term type of investing? How would you define investing?
 

JohnsMoneyTree

Active Member
Jack said:
I also don't think OP's point was to diversify their 'trading' activity into stocks.. (you were talking about having no trading edge in stocks.) Instead, I think OP was just talking about dividing up investment capital for the long term, with a portion of it was "invested" in himself for trading forex and the rest "diversified" into other assets.
Precisely. To put it colloquially, I wanted to point out that most FX traders tend to view Forex as a hammer and all their investment capital as nails. However in the long run this will be very, very dangerous to achieving your final goal, which for most of us is to retire. Diversification assists with this by ensuring that a sudden change in the market, or even an unscrupulous broker, doesn't wipe you out completely.
 

Alpha-Bet

Well-Known Member
I love the Forex and the excitement that surrounds it. It's unlike any other investment option out there, with great potential for both gains and losses.

Too excited , you're not a trader.

I may write a book one day.
 

jack

Administrator
Staff member
Alpha-Bet said:
I love the Forex and the excitement that surrounds it. It's unlike any other investment option out there, with great potential for both gains and losses.

Too excited , you're not a trader.

I may write a book one day.
He's writing for a wide audience and using dramatic effect to emphasize a point. I sometimes do the same in my own writing..

The overall message is solid from what I can tell.
 

Alpha-Bet

Well-Known Member
Jack said:
He's writing for a wide audience and using dramatic effect to emphasize a point. I sometimes do the same in my own writing..

The overall message is solid from what I can tell.
Point taken..........
JMT apologies.

Right. I have an edge as regards to currencies.
Can you tell me why i would enter another investment world without my perceived edge and invest...

I'm buying and selling money. so i'm already playing real estate, precious metals, bond yields.... how many pints the bloke drank at the pub.
 

Alpha-Bet

Well-Known Member
And you're right, bankers own the spot game and don't want to give up what's profitable for them.. so we have that going for FX traders (that the market won't be turned on its head and restructured anytime soon.) Plus, it's impractical, since the whole reason why forex can operate as well functioning OTC global marketplace is that currency is fungible.. so we simply don't need an exchange to standardize contracts and get everyone trading the same specifications since in the end, it's just currency (or exposure to that currency) that can be moved and spent no matter how it's traded... easy to clear, easy to hedge, easy to transfer... etc..

You're on the money Jack....
 

JohnsMoneyTree

Active Member
I should have been more clear when I wrote the post that it is aimed at those who haven't "found their legs yet" in FX trading. Newcomers often trade recklessly, or they get cocky after some successes and then tend to grow aggressive and take greater risks. The post was intended to remind them that there are other investment options available.

If an FX trader is successful, has a solid plan and isn't foolish enough to lose their shirt, then yes the post is a bit dry and can be seen as "pointless", but then again it wasn't aimed at people like that. :)

Words are cheap - it's finding advice that resonates with you that is priceless.
 

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