Is Diversification that important?

Is Diversification Important?

By Chris Chillingworth

A month or so ago a fellow Spreadbettor emailed me after taking a look at my Trade History which I feature here on my blog. He asked me the question “are you concerned about a market crash bearing in mind your 80% bullish right now on your account?”.

It really got me thinking, is diversification important for my style of trading? He was right for starters. A quick scan of my open positions and I saw the majority were overwhelmingly LONG positions. I then began to ask myself, “as a long term trend follower, do I need to worry about balancing my account further?”. Would I need more SHORT positions to protect myself against periods of falling markets? Is it a good habit to get into?

My LONG positions were picked because they are and have been trending long for some time. Most of them were 3 years into a LONG trend. Others had only recently started. I was riding them all in the hope that they would continue to do so for some time. I follow what a price does rather than try to predict before a move happens you see. It improves accuracy. You don’t necessarily get in and out at the top and bottom, but there’s still profit to be made if your late in and late out. Combine that with good money management and you have a decent system.

My decision to enter/exit a market is based on technical indicators and ultimately what the price is doing. This way I don’t let the news or rumours convince me to do other things. I also use very wide stops as I’m a long term trader. I’ll often place a stop 200 or maybe 400 pts away from the price. This protects me from the daily and mostly the weekly moves so I can stay in for the long haul.

So the question remained. With this system, did I need to get into more SHORTS? I spent a good 30 mins scanning the markets for any good SHORT trades and came across a couple showing entry signals. I decided to open a few. I guess my decision came from the idea that i’m quite risk averse, and as far as I can see, balancing your account and diversifying my portfolio can’t do any harm, yet I suppose it could reduce the risk of all my LONGS crashing out.

I opened SHORT on…

All the above were showing signs of a SHORT trend based on the rules I use and in I went.

This didn’t bring me at a 50/50 LONG/SHORT level, I was still mainly bullish, but with a little more diversity. I was already LONG on GOLD too, and I already have positions open on a couple of Norwegian stocks of which Storebrand has been doing rather well for me so far.

The results of the above however have really made a difference to my portfolio in recent weeks as a lot of the US stocks decided to fall for several consequitive days, exactly what this process was supposedly going to protect me against.

Firstly, my positions in $CDI and $RAI stopped out this week. $RAI was a LONG position where I lost 4% of my capital. This on its own would have been a dissapointing result, however the above process worked. Here are today’s positions on the above SHORT’s.

  • $HPQ now at $14.47 (a drop of -380 points)
  • $NAT now at $9.38 (a drop of -143 pts)
  • $BEBE now at $4.29 (a drop of -67 pts)
  • $DLTR now at $41.15 (a drop of -502 pts in just 3 days of opening, I have also opened a 2nd position in this and am at -61 pts on that.)
$DLTR which has just fallen over 500pts in 2 days.

These wins have far outweighted the losses my book would have incurred. Partially this might just be down to luck, the system, picking good trades at the right time. But also, if the market is falling for a few days, it seems good to have these SHORT positions sitting in your portfolio, following their own respective SHORT trends. It just seems to make my book healthier.

Going forward I plan to make a lot more emphasis on diversification. I’ll keep an eye out for a good entry opportunity on Forex, maybe look at some other commodities too.

Thanks goes out to whomever it was who posed the original question to me. I have always SHORTED markets, but never as much as going LONG and your question sparked a thought in my head which has led to a healthier book, a better trader and more money in my pocket. I’m just sorry I don’t remember your name and no longer have the message. 🙂


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2 Comments on “Is Diversification that important?”

    1. Hi Stephen

      No I never go that high. Which trade are you referring to exactly? I only ever risk between 4-6% on any one trade. 20% risk per trade is far too aggressive for my liking and it would only take 5 losses in a row to wipe me out. I try to keep to 4% and am working towards lowering it whilst my capital grows.

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