It already sounds pretty obvious, but investment diversification is something that any trader needs to consider when he or she begins to craft a portfolio. What portfolio diversification consists of is spreading risk across a number of different investment options, instead of opting for the “all eggs in one basket” philosophy. The whole idea behind portfolio diversification is that it is often ill-advised that you hold up an excessive amount of money in similar options. The reason for this is because it pays to balance out the level of the risk that’s present while trading. The strategy and philosophy are very simple, because with the correct diversification, you can ensure that when one option dips, another within your portfolio will cover the loss—or at least soften the impact.
Considering the underlying importance of proper portfolio diversification with forex, we’ve put together this quick guide to help you to understand just how currency trading can spice up your investments.
The Importance of Diversification
Before we jump right into how forex can help when it comes to diversifying your portfolio, it pays to understand just why diversification is so important. The reality is that the “put all your eggs in one basket” approach presents danger on an unprecedented level. A short, sharp shift in the market can completely unravel a portfolio that doesn’t spread itself across a number of markets.
Putting an example forward, let’s just say that you are heavily-invested in the airline sector and then a notable airline encounters financial difficulty, which has a subsequent impact on other airlines within the sector. This is going to seriously dent your bottom line, possibly even driving your investment efforts into the red. However, if you had taken the decision to counteract and counterbalance this with automobile- or public-transport-focused stocks, your portfolio may just be able to rebound.
The above is a very simple explanation, but it does underline the fact that without diversification (for which the forex market is a fine avenue to take), any investor is inviting on unnecessary risk.
People often discus portfolio diversification with forex and not without good reason. As every active currency trader will be quick to tell you, the forex market has always been a fine place to diversify, largely as there are so many opportunities for profit. For starters, the sheer accessibility of the market is well worth mentioning. Through other forms of investing, you are limited to certain trading windows; there is no such cap when it comes forex. Running 24 hours a day, while other markets are down, forex allows you to not only remain diversified but also remain active.
Alongside unrelenting accessibility, the forex market is also the most liquid market in the world, so you can jump directly into trading in a flash. What this also means is that any trader has the power to trade long or short freely and thus return profit in any market condition. There is also high-yield exposure potential in the case of emerging currencies, so those with a penchant for risk can play into that if they so wish.
Whether you consider it investing in a nation or simply investing in a currency, forex has the potential to spice up any portfolio. This is because it carries depth and a level of profit return that may well be the missing piece of the puzzle when it comes to keeping your portfolio in balance.
How to Introduce Forex into Your Portfolio
There will come a time when you will need to spice up your portfolio through diversification. As you can see from the above, portfolio diversification with forex is a wise route to head down, but when you make that call, where exactly should you start? The following looks at the key currency pairs that may just give your portfolio the kick it’s looking for.
Major Currency Pairs
The US dollar (USD) is arguably the most prominent currency in the world, which probably explains why it represents the key component in all major currency pairs. Either on the base side or the quote side, the USD is of crucial importance, which explains why major currency pairs are the most actively traded pairs within the forex market. These pairs often are the most liquid and carry the lowest spread. For reference, the euro vs US dollar EUR/USD is the most traded major currency pair, as it carries a daily volume of approximately 30 percent of the 5 trillion global forex volume.
Minor Currency Pairs
Currency pairs that don’t feature the USD are known as minor currency pairs (or cross-currency pairs) for the most part. During the early days of foreign exchange, the USD was used as the measuring stick, as any other currency would have to be run through it before a value could be obtained. This is now thankfully a thing of the past, hence the growing emergence of minor currency pairs. The most active minor-pair currencies are the euro (EUR), the British pound sterling (GBP), and the Japanese yen (JPY), so they are worth keeping an eye out for.
Exotic Currency Pairs
If you really do feel like branching out, exotic pairs are always an option for anyone looking to diversify his or her portfolio. What exotic currency pairs consist of are the USD and an emerging currency from a known smaller economy on a global scale, usually something that comes from outside the euro zone. Often these pairs are more volatile so give high risk but high reward trading opportunities As you might expect, these pairs aren’t commonly traded, so the related costs can be inflated.
When you decide that it’s time to diversify your portfolio, choice won’t be in short supply. But if you truly want to give your portfolio a shot in the arm, forex is where your attention should be focused. Allowing you to work within a market that’s open around the clock, with a level of liquidity that other forms of investing can’t rival, the ability to be long and short, portfolio diversification with forex is something you simply can’t afford to ignore if you wish to create a diverse, effective, and—most important—profitable investment portfolio.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.