Why is Diversification Essential?

Investments are increasingly becoming popular among many out there. It is no longer something that people fear due to risk aversion. In fact, new technologies that are constantly popping up have introduced a whole new wave of investment frenzy as digital assets like cryptocurrencies move into the limelight. So here’s the dilemma, with so many investment platforms out there, should we stick to one that we are familiar with or is diversification really all the essential?

I’m going to go out on a limb here and root for the latter: diversification is necessary if you intend to dabble with investments. That being said, what on earth is diversification all about? Well, in terms of investments, it typically means to hold more than one type of investment. Arguably, if I hold a variety of stocks, options, futures and swap contracts (and the list does go on), does that mean I’m effectively diversified? In my opinion, not necessarily so. It is certainly true that you do have different investments hedging the risks of others. However, true diversification requires you to also include investments that do have significantly lower correlation with market conditions.

Let me explain this a little. Assuming you do hold a variety of bonds and equities from different entities. If the market conditions are not favourable, you will find there your bonds and equities across the board would fare poorly as well. This is due to the high correlation of these investment products to financial markets as a whole. It is also worth noting that for many months now, cryptocurrencies have also been correlated with risk assets like stocks. As more investors enter the market, this becomes almost inevitable.

So what kind of investments are considered to have lower correlation with market conditions? The answer is forex trading. With forex trading, fluctuations in the currency market (whichever the direction) are good for traders. As such, even if market conditions are unfavorable, forex traders are still able to reap some profits from their day to day trading.

For retail investors who have little to no knowledge of forex, managed account services would be suitable. For those who are keen to try trading to hedge against your traditional investments for true diversification, why not give copytrading a shot?