Therefore reducing the potential losses of your trading account by diversifying your account will help you continue trading over a longer period while being profitable. Risk diversification is important as it helps you to preserve your capital in your trading account. This increases the confidence level of a trader in knowing how to navigate the financial markets without being affected by the uncertain occurrences of events while still trading and being profitable.

In the case of asset and fund managers, capital preservation is important to them to avoid loss of the assets entrusted to them by their clients in order to keep generating returns for them. It is the rule of thumb that for one to keep on generating returns on investment, there has to be capital. As a trader when you have the capital in your trading account, you can keep on generating income and making good returns on your investment.

This means that when you diversify your asset classes while trading when certain assets do not perform, you are still able to continue generating returns on other assets. g Tesla TSL and Apple AAPL. Diversify your investments in order to continue trading for a long period while being profitable. Subscribe now and get the latest news and analysis.

You will receive emails filled with the latest news on your favorite articles, promotions, and all other important news. Do you feel your trades are restricted by your account size? Your trades and investment Over the years, the Forex market has attracted a large number of investors. More people are recognizing the earning potential of Forex Flexibility with popular currency pairs is always a great advantage for traders.

Tellingly, the account will suffer if the original trade idea was wrong. If the EURUSD and GBPUSD end up with losses, the same will happen with the other two. The aim is to master avoiding losses. And only next to focus on making money. For this, diversification method helps. And, avoiding correlated markets is the first and most crucial step in the process. This part refers to currency trading only. From all the products offered by a Forex brokerage house, the currency pairs are the most numerous.

As mentioned earlier, currencies reflect the strength of an economy. The stronger the economy gets, the higher the interest rate for that currency will be. Hence, investors will favor buying it.

Think of the Forex dashboard as representing the entire world economy. Because, in fact, it does exactly that! Moreover, think of countries like the United States, Canada, Mexico, Japan, Australia, Switzerland, to name a few.

Or regions like the European Union. Studies show that normal economic growth requires certain inflation levels. Hence, while the official mandate of all central banks is to safeguard price stability, in fact, they stimulate economic growth. The diversification method refers to avoiding currency pairs that have the same currency as the dominant one.

And, in currency trading, that is the U. A huge chunk of international trade is done in USD. Commodities like oil, gold, and so on, are priced in USD too. Moreover, foreign nations around the world choose to keep their excess reserves in USD. Not in the local currency! For all these reasons, the USD pairs act in a correlated manner. One thing is to avoid trading correlated USD pairs. As you noted already, intra-market correlations refer to correlated currency pairs. However, other currencies enjoy a correlation too.

And, while in the case of the USD the correlation was a direct one, in the case of commodity currencies, the correlation is inversed.

Or, it is a direct one, but the currency pairs act in an inversed manner. Specifically, we refer here to the AUD Australian Dollar and CAD Canadian Dollar. When talking about correlation, we must discuss the correlation degree too. Or, if they do, it is an artificial peg. Like, for instance, the EURCHF was all the time the price was pegged to the 1. For as long as the peg held, the 1. The further the cross pair went higher, the lower the correlation degree became.

In this case, currency trading was reasonably easy. All traders needed to do was to understand the EURCHF, EURUSD and USDCHF triple correlation. Or, the one that defines the two majors and their cross. Namely, when the EURCHF got closer to the 1. Instead, trading more than one pair would mean overtrading. Besides correlated currency trading, some other correlations exist.

And, they will influence the performance of a trading account. Traders easily fell prey to the temptation of trading a market just for the simple fact that is open. Or, that the broker offers it. Of course, the broker has the interest that traders open and close as many positions possible during the trading day.

A technical setup means that the trader has a strategy based on technical analysis principles. Regardless of the nature of the market, using the same indicators should give the same results. As explained earlier, correlations do exist.

But, correlations have different degrees. Some markets have a tight correlation, some other ones a looser. Enough with correlations. But also, the best friend once understood how they function and how they affect the trading account. The last thing to do when applying diversification method is to split the trading account. Or, to split the potential investment.

It is obvious that the diversification method depends on correlations. As correlations in currency trading are of multiple types, one needs to be careful when deciding to buy or sell a currency pair. All in all, applying diversification method requires understanding the trading account and the financial markets. After all, what is the diversification method in Forex if not that?

Your email address will not be published. Applying Diversification Method in Currency Trading Muhammad Awais July 17, No comments. Principles of Applying Diversification Method in Currency Trading The starting point to any money management system is understanding the trading account.

Risk diversification therefore in trading is the concept of allocating funds or trading account to different asset classes and financial instruments in order to spread risk and preserve capital. You are equally as a Forex trader need to understand how you can diversify your risk while trading the Forex market.

As a trader investing your hard-earned money in the Forex market, you need to be aware that there is risk associated with trading. You however need to understand that diversification is a way to minimize the risk of your losses. When certain investments or asset classes perform poorly in the short or long term, other trades that you could be invested in could perform better over the same period.

Therefore reducing the potential losses of your trading account by diversifying your account will help you continue trading over a longer period while being profitable.

The strategy of diversifying an investment portfolio allows the fund manager to spread risk between various different investment types with the same portfolio. In essence, if you keep all of your funds invested in similar securities like either bonds or stocks denominated in a single currency, then your portfolio will not be protected against adverse general moves in the relevant markets.

Nevertheless, if you instead diversify your portfolio by placing funds in different types of investment instruments denominated in different currencies, then you will have less exposure to any one security, currency or market. Using traditional portfolio diversification techniques, investors will often purchase a mixture of stocks and bonds to hold in their investment portfolio. They generally do this to protect or hedge against the risk of an economic downturn by holding bonds that will continue to pay interest, while at the same time still being able to profit from good economic times due to the probable appreciation of the equities they are holding.

When this happens, the bond interest received may not adequately compensate the investor for the loss of capital experienced on their equity investments. Although Forex trading is certainly not the same as investing, those involved in investment management might wish to consider adding an extra diversification element to their portfolios in the form of using different currencies.

Furthermore, according to the goals of an investor, they could even choose attractive fixed income or equity assets from several different countries to add currency diversification and balance to their portfolio. An alternative for those who need to maintain all of their assets denominated in their local currency would be to exchange just the portion of the portfolio held in cash into a different currency. Ideally, they would choose to switch into a currency that would be expected to appreciate relative to their local currency and which may even provide a superior interest rate return on deposits.

Since currencies can be looked at as the stock of a nation, investors could even elect to hold a diversified basket of currencies. This would allow them to invest in various nations that they expect to show superior growth rates and moderate inflationary pressures.

In general, the currencies of countries which are growing well and offer higher interest rates and low inflation will tend to have a stronger currency that may well appreciate relative to the currencies of those countries that have weak economies, lower interest rates and higher inflation. For example, with U. growth flagging and its interest rates currently near zero, a U. based investor well might be inclined to consider alternative currencies to switching their U.

Dollars into. Accordingly, the investor who switches from U. Dollars to Australian Dollars would benefit from an interest rate differential of roughly four percent on their cash. Also, provided that inflation remains under control in Australia, these factors should eventually lead to a higher exchange rate for the Australian Dollar versus the U. Dollar over time as an added investment incentive. Understanding Forex Regulation The foreign exchange market, despite being the largest financial market in the world, has no formal exchange or centralized location.

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Contents hide. How Portfolio Diversification Traditionally Works. Adding a Currency Dimension to Your Portfolio. Investing in Currencies. Related Articles. Get daily updates on Forex News. IMMFX uses cookies to be able to give you the best experience on our website. By continuing to use our site, you agree to the terms of our privacy policy.

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By continuing to use our site, you agree to the terms of our privacy policy. Intra-Market Correlations to Avoid — the Commodity Currencies One thing is to avoid trading correlated USD pairs. Market participants are wondering how things will end with increasing inflation, stock prices plummeting, geopolitical tensions in Eastern But this is nothing new to Forex traders as money management rules like diversification method applied to a trading account help avoiding large drawdowns. Hence, while the official mandate of all central banks is to safeguard price stability, in fact, they stimulate economic growth. g Tesla TSL and Apple AAPL.

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