11th July 2019
A robust investment portfolio attempts to generate gains in all types of market conditions. When building an investment portfolio, you should allocate your assets to several different types of financial instruments and strategies to create a diversified portfolio.
The most efficient portfolio is a diversified portfolio which has an asset that is generally uncorrelated with another one. To create this type of investment portfolio, you need to trade several different asset classes. You also want to employ various trading strategies that take advantage of various market conditions.
An asset class is a group of tradable products that have characteristics that are similar. The major capital market asset classes consist of stocks, bonds, commodities, currencies, cash, real estate, and alternative assets.
Generally, an asset within an asset class is subject to similar regulations. An asset class is expected to exhibit various risk profiles and perform in different ways in specific market conditions. For example, as interest rates decline, the price of a bond will rise.
When you invest in the capital markets, you want to build a portfolio that holds several types of asset classes. This will provide you with returns that can perform well in differing market conditions. The best way to hedge against adverse market conditions is to have a portfolio of assets that vary from one to another. If instead, you purchase several assets that move in tandem with one another, you are subject to large swings in your portfolio if the market moves against you. For example, if you only owned financial stocks in 2008, you would have lost most of your money.
It's important to create a diversified portfolio of financial instruments that do not move in tandem with one another. To do this, you can run a correlation analysis. Correlation analysis generates a correlation coefficient, which tells you if two or more assets move in tandem. A correlation coefficient of 1, tells you that the two assets move perfectly together. A correlation coefficient of -1, means that the two assets produce returns that move in opposite directions. A correlation coefficient that is below 50 and above 50, means that there is no clear observable correlation between the two assets. These would be considered uncorrelated assets.
Not only do you want to diversify the portfolios you create with different assets, but you also want to have diversified trading strategies. The reason you might want to use different trading strategies is to capture gains during various types of market conditions. You might consider a trend following strategy, a momentum strategy, and a mean reverting strategy. If you are trading stocks or bonds, you might consider a buy and hold strategy along with a pair trading strategy as well as a technical analysis strategy.
Markets move up, down, and sideways. Nearly 70% of the time, markets are consolidating gains as buyers and sellers jockey for position. When markets are moving sideways, you need a strategy that will generate gains. For example, during the first four months of 2019, the EUR/USD moved in a four big figure range.
A trend following strategy would have a difficult time generating profits during this period. Traders who used mean-reverting strategies might have had a better chance of being profitable. Since nobody knows when the markets will break out or begin to trend, you need to have multiple strategies available to take advantage of each market condition.
Determining how much of your capital you should allocate to each asset class and to each individual strategy should be based on your risk appetite. Remember the more money you risk, the higher your reward. Investors sometimes forget that they are paid to take risk.
If you want a risk-free investment you should invest in a government sovereign short-term bill. In the US, three-month Treasury Bills are providing investors with 2.5%, which is risk-free. This is how much you will make over the entire year. Since inflation is running at 2%, your real return is 0.5%.
You can diversify your portfolio using a mix of strategies and financial instruments, which could include day trading as well as long-term investing. As an investor, when creating your investment portfolio, you want to create one that generates gains in all types of market conditions. You should allocate your assets to several different types of financial instruments and trading strategies.
The most efficient portfolio is a diversified portfolio which has an asset that is generally uncorrelated with one another. To create this type of investment portfolio you need to trade several different asset classes, as well as a number of trading strategies to tackle markets when they are trending as well as moving sideways.
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