There is a common held belief among many investors that diversification is good. It may have been taught to them in school. It may have been taught to them by their parents. It may have been taught to them by many financial advisors.
And to many people, it makes logical sense. Most people are risk averse, especially if they have a family. Therefore, when they hear the common mantra of diversifying and not putting all your eggs in one basket, it makes sense to them. After all, if one investment goes bad, or if one trade goes bad and you lose 100% of that, you still have diversified into other stocks, trades, financial instruments. They make the assumption that some of the positive investments will help to counter the negative performance of other investments. That may or may not be true, depending on how correlated the investments/trades are, and what the global macro environment will be.
Correlated Investments/Trades Can Crush You
For example, there were many people who thought they were diversified into different stocks during the 2008 market crash. When in reality, the global macro environment was going to crash all stocks. It didn’t matter if you were diversified or not into different stocks. Almost everyone who tried to be long equities during that time period lost money.
Now on the other hand if you had a diversified strategy to be short equities in a certain percentage of your portfolio that is a different story. That could of shielded you from losses, or even made gains if you were short enough shares.
Now some people may say, well the strategy is to hold through those market crashes in order to play the market for the long term, etc.
That may or may not be sound advice for someone who wants to passively invest for retirement. If you do not want to spend the hours, or bring the determined effort and intensity in order to generate out sized returns, then diversification may be for you.
However most traders and speculators do attempt to spend the hours and have determined effort. I don’t specialize in generating mediocre returns of 5-10% a year and attempting to grow that money for retirement which is 20, 30 or 40 years away.
I personally am not interested in spending hundreds of hours on trading in order to invest the money and grow a retirement nest egg. That’s the slowlane. In the long run we are all dead. When am I supposed to enjoy the money? When I am in my 60’s and 70’s? I don’t want to spend countless hours in order to enjoy the majority of the money at some point decades later.
I would rather have the money now, within the next few months and next few years. Then you gain financial freedom and have time to figure out what you want to do with your life. If you like trading and like the process of finding great trades, then you can continue to trade. At least you have more choices than other people.
You work hard, work smart at trading for many months or a few years, but you want the results, the money, the wealth to occur within a few years and not take 40 years to come to fruition.
Forex is trading, not investing. You are not going to find many people holding currency positions for 20, 30 or 40 years. That is not how the currency markets operate. I talk about the differences between investing in stocks and currencies in a previous article.
You are not going to find many active traders who are attempting to trade forex in order to generate a small, mediocre return in order to save for retirement decades away. Many beginning traders do not have that type of commitment. The majority of beginning traders just like hop on some forums, check out some expert advisors or moving average crossovers, and hope to get rich. If that doesn’t work out in a few weeks, or few months they will tend to quit forex and quit trading.
Forex is not designed for the getting wealthy using the slowlane approach. Although you can choose it of course and risk a tiny % per trade or use no leverage at all. No one forces you to risk 2% of your account on every trade. No one forces you to use leverage. If you have $100,000 in your forex trading account, you can always use no leverage and just place a trade for one standard lot.
Forex trading, especially capturing the explosions in volatility are there waiting to make you rich. You just need to have an order flow and liquidity mindset in order to perceive them and take advantage of them.
Soros Breaking the Bank of England
When George Soros broke the Bank of England, he didn’t care about diversifying. I assure you that was the last thing on his mind. He wasn’t thinking about diversification when he bet his entire hedge fund + leverage shorting $10 Billion British pounds. He was thinking about the money, the wealth, the quick hefty profits. The trade lasted a few days, weeks, or 2-3 months at maximum.
Soros has said that when he believed he was right no investment position was too large. Well, you also need to be right on timing and being right on liquidity as well.
Where the Big Money Is
Far too many people use diversification as a hedge against ignorance. They do not want to do the research, the order flow, liquidity, sentiment, sensitivity, global macro, and scenario analysis research in order to find the good trades and investments. They refuse to do so, therefore they choose to hedge against this ignorance by diversifying. Even Warren Buffett thinks so.
Big money is made by taking meaningful positions when you are certain the odds are in your favor. This requires a high degree of certainty.
I would rather place one meaningful, concentrated trade which is researched and perfectly timed, rather than spread that risk capital among five poorly conceived trades, if the market environment allows such trades to be placed.