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How to diversify a trading account

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

How to diversify a trading account

October 30, 2018

The currency market is the biggest financial market in the world. With over five trillion dollars changing hands every day, the foreign exchange market captures the imagination of many.

If anything, it is the one place where anything is possible. Fortunes can be made and lost, but as long as there is the possibility to make it, the retail trader will pour in.

The Internet made it possible for online trading to become a reality. And, for Forex brokers to offer better and better conditions for accessing the interbank market.

A couple of decades ago this was merely a dream. Today, it is a reality, and retail traders enjoy rare trading conditions when compared with those available then.

However, progress doesn’t come one-sided. Not only retail traders rip the benefits, but other market players too.

As such, trading became more and more difficult, the role of high-frequency trading increasing day by day, and with volatility decreasing due to trading algorithms activity. Many times, algo’s only dip to take the stops on the previous lower swing, then spike to trip the ones on the last higher swing and then settle for the middle range.

The retail trader is stopped and doesn’t know what to do next. Statistically, most of the retail traders (over ninety percent of them) lose their first deposit.

Not everyone must be a trader. This is a tough job, with players having more resources and research than a single individual.

Therefore, to survive and to have a chance of making in this world, the retail trader has to switch the focus on education and money management. First, stop losing, and only then focus on the potential win.

Diversification as a Money Management Tool

Money management deals with managing the risk in a portfolio. Because Forex brokers offer now not only currency pairs, but other markets too, like gold and silveroil, major stock indices, and even cryptocurrencies, plenty of opportunities exist.

Like it or not, a trader must first learn money management skills. Or, how to protect the trading account from losses. And only after that, on how much to make. Otherwise, the big guys will eat traders alive in a blink of an eye.

Many times, there’s nothing wrong with a trading strategy or setup. However, because of trader’s greed or fear, the account still disappears. As such, the only remedy is discipline and a trading plan to follow no matter what.

The amount to fund a trading account doesn’t matter. Savvy money managers use percentages to allocate the resources in various markets.

Before moving forward, keep one thing in mind: if you treat trading as a hobby, there’s no way to make it in the long run. Everyone dreams of trading for a living, but this is not a game, but real people with real money, so make sure you understand that.

Cash is King

It may sound out of this world, but it makes sense to keep a cash position all the time. It provides free margin and avoids the opportunity cost (traders can add to the current portfolio when the right opportunity arises).

Anywhere between fifteen to twenty percent in cash will do the trick.

Split Between Various Markets

Most traders will have a problem here. They’ll argue that they don’t trade oil, or gold, or the U.S. stock market…. they only trade Forex.

That’s wrong. Intermarket correlations tell you that if you trade the Canadian Dollar, for example, you’re exposed to the oil market. The same with JPY and the U.S. stock market, and so on.

Hence, split the rest in the trading account between all the products the broker offers, in equal parts. For example Forex, commodities (oil, gold, silver), indices.

Forex

For the Forex market, avoid correlations. If bullish the EURUSD, and have a proper set up, don’t just buy the GBPUSD, sell USDCAD, buy AUDUSD at the same time. It doesn’t make sense, as most of the times it is like buying four different positions on the EURUSD pair. That’s overtrading, and, in the end, it kills the trading account.

Instead, focus on majors and crosses. Major pairs are the ones that have the USD in their componence, and crosses are the ones without.

If anything, take another USD trade but on a different day. This way, the market may offer another possibility to enter a trade.

Also, split the trades into scalping, swing trading and investing, in equal parts.

Commodities

Further split the amount of trade into two different parts: one for oil and one for gold and silver. Either swing trading and investing in oil, and scalping on gold or silver, or the other way around.

This way, the trading account further diversifies.

Indices

Avoid the correlation with any possible JPY trades that might be open. If interested in getting exposure on the U.S. market, for example, trade one index as a buy and hold, and another one as a scalping and swing trading opportunity.

Conclusion

The risk here is to over-diversify. An over-diversified account gets too much protection, but minimal reward.

For this reason, make sure to use risk-reward ratios that make sense, like 1:3, meaning for every pip or point risked, the reward is triple that.

As such, even if the portfolio may stay in balance for a while (remember, the focus is first NOT to lose, then to make a profit) when the market eventually breaks, the risk-reward ratio makes sense.

Finally, risk only a percentage of the trading account on each trade. A conservative approach uses one percent, an aggressive trader, two percent, but in both cases, the risk-reward ratio is a must.

No one says it is impossible to lose a trading account with all the safety measures in the world. However, trading is a game of probabilities. Taking the steps described in this article increases the chances of making it in the Forex market.



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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

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