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What is diversification in the Forex market?

What is diversification in the Forex market?

What is diversification in the Forex market?

Regardless of whether you invest in certain assets or trade them, any activity in the financial markets is always subject to a certain risk. At its core, diversification is a process of investing in different assets in order to reduce risks.

Why do you need to diversify your assets in the Forex market?

The essence of diversification is to secure your funds using various trading strategies and tools. Proper diversification will allow you to make a profit regardless of the situation in the financial market.

The main goal of diversification is to protect the trader from a complete loss of funds because of unexpected negative circumstances.

The same rules apply in the Forex market, where diversification implies a variety of trading instruments in such a way that potential losses on one instrument are offset by profits on others.

It should be borne in mind that you cannot simply scatter your funds among various trading instruments. Thus, you will not insure yourself against risks, rather, on the contrary, only increase them. A properly diversified portfolio should be broken down into high-yield, high-risk risk assets and low-risk assets. In other words, the portfolio should consist of minimally related assets in the macroeconomic sense. Nevertheless, a diversified portfolio reduces not only potential risks, but also potential income. Therefore, lovers of aggressive trading often speak negatively about such strategies.

What types of diversification are there in the Forex market?

There are several methods of diversification in the Forex currency market:

  • Diversification by trading accounts

A trader opens several trading accounts with one or several brokers and trades on different currency pairs using different strategies. In other words, the trader is hedging his risks.

  • Diversification by trading instruments

A trader use different currency pairs which are dependent on each other in such a way that the dynamics on one currency pair has the opposite correlation on another.

Conclusion

Unfortunately, even with a well-diversified portfolio, it is impossible to completely avoid losses. Therefore, each trader must adhere to other basic money management rules. For example, you should not deposit more funds to the trading account of a trader's trading terminal than is necessary for trading. Proper diversification will help to significantly reduce the risks of trading in the Forex market.

Article last updated: 2022-05-11

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