In the world of investing, the concept of having a portfolio is widespread. A portfolio is simply about diversification. The objective is maximizing returns in different, sometimes uncorrelated assets.
Moreover, by being well-diversified, you reduce your overall risk. In a nutshell, it’s about never putting all your eggs in one basket. Investors or traders want to take advantage of many different opportunities rather than spreading themselves too thin.
Interestingly, not many think of building a so-called forex portfolio. It may be because this market is often speculator-driven, where we have fewer so-called buy-and-hold investors.
Yet, you can undoubtedly diversify with currencies to achieve the same goals of having a portfolio in the first place; it’s just the mechanics are distinct.
There are several benefits of being diversified, with some of the wealthiest investors and traders using this strategy. This article will provide the framework for building your own portfolio in forex based on personality, market selection, risk appetite, and goals.
Tip #1: Defining your goals
Like any portfolio, investors divide this into particular sections. Yet, what you should define first are the strategies you’ll implement in the markets.
Broadly speaking, you can become an active speculator in forex (day trading, scalping, swing trading) or hold your positions for the long term (position trading). The trading style one chooses depends primarily on their goals which affect your risk appetite.
Generally, if your goals are short-term, where you seek to produce gains over days and weeks, you will need to become an active trader. Such intentions may include paying for living expenses or material possessions.
Age certainly plays a role when defining your objectives. The younger one is, the likelier they are to engage in more active speculation since they have more time and enthusiasm to deal with volatile markets.
As you get older, your risk appetite decreases over time, particularly if you have more capital at your disposal or less time to follow the markets.
If your time horizon is over months, a year, or more, you don’t need to follow the markets closely and take many positions. Your goals might be saving up for a large purchase over the next few years, growing your net worth, or even saving for retirement.
Fortunately, one isn’t limited to exclusively having a short or long-term objective regardless of age or experience; you can strike a balance between the two where your portfolio reflects both goals.
Tip #2: Dividing up your portfolio
Any diversification strategy aims to split a portfolio into particular categories. Forex investors and traders can separate their holdings into aggressive, balanced, and conservative.
Of course, you aren’t limited to only splitting your portfolio into such groupings. Instead, some simply go aggressive or conservative based on their goals, as explained in the previous section. However, these divisions provide workable guidelines.
- The aggressive portion is the part where one believes they can produce the most profit in the quickest time possible. You’d need to employ active trading strategies for a chance to achieve this mission as it’s not feasible with a more laid-back approach.
It’s essential to choose markets with low spreads, namely your major or USD-based pairs and most minor or cross pairs (EURNZD, EURGBP, GBPAUD, GBPCAD, etc.).
However, being aggressive comes with high risk, which increases the more frequently you execute in the markets.
- A balanced portfolio is not too aggressive or conservative. You expect moderate risks and moderate returns. For instance, someone might divide their capital by allocating 50% or 75% of the amount to the former and the rest to the latter. This would consist of a mixture of short-term and long-term strategies.
Most of the time, you can day-trade or swing-trade on all available markets, mainly using technical analysis, and then hold a few long-term positions on other pairs based on more economical/fundamental data.
- A conservative trader/investor looks for low profits with low risk. Someone with such a mindset will undoubtedly need to be a position trader where they hold positions for extended periods (several months or years).
With this approach, one would need to focus more on notable economic disparities underlying the values of currency pairs to have the best chance of a potentially prolonged bull or bear market.
In this part of the portfolio, it’s beneficial to have knowledge on interest rates by buying currencies with high rates and selling them against those with low ones. This strategy is known as the carry trade, where you plan to earn positive swaps or interest by exploiting these differentials.
Exotic markets are particularly suitable for this approach since they are based on emerging economies with naturally higher interest rates.
Tip #3: Being aware of correlations
While there are tens of forex pairs to trade, most people follow around 25 to 30. Even in this handful, many of these markets tend to move in one direction or the other because of the inherent correlations.
You need to be aware of the relationships between currencies to ensure you’re not doubling up your risk. For instance, it’d be dangerous to have a buy order on EURUSD and a sell order on USDCHF at the same time since both of these markets historically move in opposite directions.
This means their outcomes would amplify one result, and if the price moved unfavorably, you could lose a lot more than intended. So, generally, you should understand which currency or economy you’re being exposed to the most and where you might need to reduce this exposure whenever you open a position.
Final word
Of course, diversification is not always seen favorably. The great Warren Buffett once said, “Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.”
Mark Cuban even went as far as saying, “Diversification is for idiots!” However, there is an argument about never relying on a handful of markets, particularly if you’re a long-term trader.
The diversity in the range of forex pairs makes it possible to split up your risk into different categories where you can take advantage of as many opportunities as possible. So, if one market is performing against your portfolio, you won’t feel so bad when another is doing well for you, meaning your net results can be more favorable.
