Work in the financial markets implies high risks. For this reason risk management is the most important component of the trading strategy of any self-respecting trader.
It is important to learn how to allocate and manage risks so as to anticipate any situations of potential loss. You must be prepared in advance for losing your savings. And to prevent this from happening, you need to control your capital.
Diversification in Forex and in investments represents the distribution of your capital among different investments in such a way that possible losses on one of them are compensated for by profit from other projects.
Any experienced investor divides his investment portfolio into two parts:
- high-risk assets with high returns;
- risk-free low-income projects.
Beginning investors often confuse the concept of diversification with a simple spread of assets with different indicators of risk and return. They think that by scattering their capital in various projects they will save themselves from total loss of funds. This is one of the most common mistakes newbies.
Forex Risk Diversification
Many traders are wondering - is it possible to diversify risks in Forex trading? Of course, yes! And this must be done to reduce the risks and protect your capital from a full or even partial discharge.
This can be done through the distribution of trade across different assets - currency pairs. A lot of pairs are available to the trader, each of which has its own special properties and volatility. Some couples are able to overcome a large number of points due to sharp jumps in a short period of time, while bringing great profit. Others are calmer and more predictable in terms of Technical Analysis.
It is for this parameter that traders can be divided into aggressive and conservative. The first in a short period of time can earn much more than the latter. But at the same time, the risk of losing a deposit also increases, since the price can at any moment turn completely in the opposite direction.
As an example, consider the currency pairs USD / CHF and GBP / JPY. The first for many years is considered an asset "refuge", a kind of safe haven. Its dynamics is calm, even during the instability in world markets on the chart for this pair there will be no sudden unpredictable jumps. But the GBP / JPY constantly jumps to a large number of points in a short period of time.
Thus, even if a trader prefers aggressive trading on GBP / JPY, diversifying his risks with parallel trading on USD / CHF, he can significantly reduce his risks and hedge against a failed deal with the pound.
In order to competently diversify risks in the Forex market, you need to create your portfolio of two completely unrelated to each other currency pairs. That is, those that have a low level of correlation.
Diversification, though it is a mandatory item of money management, but it has one significant disadvantage, due to which many traders begin to neglect it. The more we try to reduce risks, the less the potential profit becomes.
Many traders believe that if they start trading in such a risky market, then they should trade large to earn a lot.
From the point of view of psychology, experienced pros advise you to mentally say goodbye to the money you invest. It does not matter, Forex is or other areas of investment. Therefore, in no case should you trade on borrowed funds. Otherwise, work will not be fun, and life will turn into slavery!
Diversification classification in forex
Some traders diversify their risks as a result of trading in different currency pairs. Others make up the trading strategy of several tactics. There are those that combine all types of risk sharing.
Diversification in Forex can be divided into the following types:
- on trading strategies.
As part of this diversification, you combine different strategies one currency pair. This will significantly reduce the risks and get the maximum benefit from the current market situation. For example, on an hourly timeframe, you can open a trade for a raise as part of a trend strategy, and on an 5-minute trade skalpingovoy strategy from the support and resistance levels of the channel in which the price moves. Many traders open trades at the same time. the trend, and on lower timeframes, they conduct short-term trading against the trend within the framework of the classical technical correction.
- on trading accounts with one broker.
Modern brokers provide the ability to open multiple accounts. Each of them has its own characteristics and advantages, due to which you can get a certain benefit. You can open several accounts and trade for different currency pairs. As a result, even if one transaction is closed in the red, then due to the profit on the second, the losses on the first will be partially or even completely covered.
- on trading assets.
In Forex, you can trade in different currency pairs. Each has its own characteristics and volatility. The degree of dependence is called correlation. It can be both direct and reverse (when the dynamics of currency pairs are completely copied, but with a mirror opposite). Some currency pairs have a strong correlation, others, on the contrary, do not depend on each other at all.
For example, if a signal to sell appeared on EUR / USD, then you can open a parallel trade on GBP / USD. And all because these two currency pairs have a strong correlation.
Diversification of the investment portfolio
Yet most of all the concept of risk sharing refers specifically to investment activities. Here, the concept of diversification implies the distribution of capital between several investment methods in order to reduce the risks of losing the entire amount of your investment portfolio.
You can both trade independently and in parallel entrust some of your funds to other traders as part of PAMM Investing. To reduce risks, open a bank deposit. Although the yield on them will not be so high, but the risks of losing money here are practically reduced to zero. It will be a kind of your airbag, which can, if not reduce potential losses on other projects to zero, then at least reduce them.
The main rule of successful diversification is “not to keep all eggs in one basket”.
If you are engaged in trading on Forex, it is better to have an additional source of income from another area in parallel.
Basic principles for successful diversification
The risk management method involves the following aspects:
- risk distribution and management;
- net profit on a stable basis;
- capital principal insurance.
One of the options for proper risk allocation is presented in the screenshot above.
As for the risks in Forex, they can be divided into:
Forex trading may not always be completely under the control of the trader. The trade risks here include drawing up the wrong trading strategy, the predominance of emotions over the mind, technical problems on the platform of the broker.
In order to protect oneself from trading risks, in most cases it is saved by the presence of a well-thought-out trading strategy and plan, composure and a complete lack of emotions, as well as discipline and self-control.
By non-trade risks of a trader include fraud by a broker. If you have invested in a PAMM account, there is always a risk of losing money due to the inexperience of the account manager.
But here you can reduce the risks. To do this, cooperate only with trusted broker companies and in no case invest in questionable projects. Read reviews, check license availability and so on. As for PAMM accounts, you should treat them with extreme caution. Often the rating that is specified in the profile does not correspond to reality at all.
To avoid such non-trading risks, there is diversification by opening several trading accounts in different brokerage companies (but in no case the same, otherwise you will simply be blocked). If suddenly one company has deceived you, then you will be able to recoup at the expense of another, more reliable.
It is best not to trust your capital to other people, unless it is your trusted friend. Learn to trade on your own!
Risk Management in Forex
With competently diversifying their risks in Forex trading, it is necessary to divide trading assets into two groups:
- assets with a high probability of making a profit, but also the corresponding high risks.
- risks are practically reduced to zero, but the profit will be insignificant.
Some newbies distribute their deposit among trading assets with a high level of correlation. This does not guarantee your safety of funds at all, since in case of unforeseen circumstances the losses will be doubled, since the dynamics of such assets is identical.
To succeed in trading, you need to build your trading strategy in such a way that it contains both aggressive and conservative methods. The first will allow you to get much more profit due to the opening of large volume transactions. But there is a high risk that even a slight correction against the main trend can lead to a complete loss of funds in the trading account.
Due to the conservative trading method, the trader will consistently make a profit in the amount of 5% per month on average. Even if it is not a significant amount, it is almost guaranteed at 100%.
Earlier in the article the correlation effect was already mentioned. All currency pairs in Forex are interconnected with each other. Only among some, this relationship can be traced strongly, while for others it is practically absent. It is thanks to the competent combination of such trading assets that one can learn to manage risks and minimize them. After all, the profit on one currency pair can cover the losses on the other.
This technique will only be valid if there is a clearly defined and proven trading strategy. The main essence of this risk distribution method is the simultaneous opening of several orders in different directions, but on different timeframes.
We will need a four-hour H4 schedule and a half-hour M30. It is this selection that will allow you to earn correctly both on trading with a global trend and during a correction against it.
What is the global trend in Forex? This is a trend that continues in the long term. The trends that we see on 5-15 minute timeframes - these may be no trends at all. They are not stable and can at any time change the direction to the opposite. And without any reason, since the price dynamics here may be subject to market noise.
Corrections against this trend can be caught on the M30 and H1 timeframes. This is a change in price movement in the opposite direction, which is limited.
The procedure for diversification:
- After identifying a global trend in the H4 or D1 charts, the trader opens the first trade.
- Further, we observe and wait for one of the oscillators to signal that the trading asset has moved to an overbought zone (with an uptrend) or into oversold (with a downtrend). The Stochastic or the Relative Strength Index RSI does a great job of doing this.
- Moving to a lower timeframe to search for signals to open trades in the opposite direction. The reversal can be searched for using the Parabolic, Moving Averages or Ichimoku indicators. They are perfectly capable of catching both the beginning of the correction and its completion.
- We are opening a second deal in the opposite direction from the global trend, but within the framework of a new, emerging correction.
Why is this strategy most effective? After all, many experienced pros have long been trading solely on it.
The fact is that the price never moves within its main trend in a straight line. It has a wave-like pattern of movement. Therefore, even if we observe growth on higher timeframes, then on younger ones the price will fall within the mini-trend, which on older charts will look like a normal correction.
Recommendations and advice
In order to maximally protect oneself from risks in Forex trading, I recommend following simple recommendations from experienced traders:
- As part of the main capital management rule, do not invest in one transaction an amount that exceeds 5% of the total amount of your deposit.
- You should not use a large leverage, especially for beginners. The recommended threshold is no more than 1: 100. Now many brokerage companies offer their customers leverage in 1: 1000. This is very tempting, I agree. After all, it is possible to earn a large amount of money with a small capital. But in this case, any reversal of the price “not there” can “eat” your deposit in a short time.
- Spread your capital into several unrelated opportunities for earning income on Forex.
The above is an example of the diversification of one of the experienced professional speculators.
To become a successful investor and trader, you need to learn how to properly diversify your risks. This is an important component of success, which in no case can not be neglected. It is the proper distribution of your capital that will not only keep all funds safe, but also make it possible to profitably earn and receive large passive income! You can diversify your risks, as well as within one Forex, and among other areas of Internet earnings.