The capital markets can be volatile and one of the best ways to insulate yourself from choppy market conditions is to build a diversified portfolio. The process involves capital allocation to different portfolios and several diverse asset classes to reduce the volatilility of your returns. Once you have determined how much capital you will allocate to a specific venture you can then devote strategies to several assets.
What is Asset Allocation?
The first step in building a diversified portfolio is to allocate a specific amount of capital to an investment strategy. You first want to determine how much distretionary capital you have available. Try to avoid using funds you need immediately to trade the markets. Money that you need for rent or food should not be used to speculate on the capital markets. You should then allocate your discretionary funds into different strategies. This could include day trading, retirement, saving for school, etc…
Diversify Your Strategies
Once you have allocated capital to investing, you want to divvy up the capital into strategies. If you are planning to trade the capital markets, you want to make sure that you use several different strategies. By doing this, you avoild having all of your capital in one place and potentially loosing a significant amount of capital if a strategy is unsuccessful. Different types of strategies include directional trading, systematic trading, market neutral trading strategies, as well as discretionary trading strategies.
Directional trading is generally the most difficult but can be the most lucrative. Picking the immediate direction of an asset takes practice and an edge. You want to make sure you have a methodology that you can rely on. Systematic trading strategies can be very efficient, but you need to make sure you do signficant research on a system before you begin to risk real capital. If you have the option of using a demonstration account to test drive the system, you are more likely to be successful over the long term.
Market neutral strategies help avoid prices volatility. You can do this by pair trading where you are long one asset and short another. On the iFOREX investing platform, you can trade this strategy by trading their sector ETFs or shares. Many market neutral strategies use these types of strategies using equity indices. You can also trade this type of strategy using cryptocurrencies.
Trading Several Assets
You also want to make sure that you diversify the assets you plan to trade. This will allow you to benefit from several opportunities and help you avoid losing large sums of capital if something goes wrong with one specific asset. By having trading strategies that focus on several different assets you increase your odds of winning in many different assets. For example, if you design a trend following strategy, you want to give yourself the best opportunity to be successful, by trading many assets that could trend.
By allocating capital to many different strategies and using several different types of assets to take advantage of those strategies, you provide yourself with a diversified portfolio that could provide the most efficient risk adjusted returns.