How to Trade Stocks – Investment Tips For Diversification Strategy & Asset Allocation
If you are looking for good investment tips, diversification strategy and asset allocation are important things to look for when learning to invest and how to trade stocks. There are some common misconceptions about the difference between asset allocation and stock diversification.
Diversification Strategy Vs Asset Allocation
Diversification generally means you have a portfolio of diversified investments within a given asset class. Asset allocation considers the overall diversification strategy which includes the percantage of your asset within each asset group and generally implies that you are allocating your assets to more than one asset class. One version of asset allocation might be a diversification strategy among multiple asset classes so that you allocate your assets to 20% gold, 20% stocks, and 60% real estate.
On the contrary, diversification could result in a balanced portfolio of stocks, while owning no real estate, gold, oil, or any other assets. That doesn’t neccesarily mean that having diversified investments among one asset class is a bad thing. If someone knew how to trade stocks very well, he or she might be better off having a good diversification strategy among stocks and having an asset allocation of 80% stocks and 20% cash. If you don’t quite understand it yet, it will all make sense soon. Diversification strategies, usually have diversified systems of investments. This strategy may simply be a stock trading system or ETF system that strives for portfolio balance overall. If you want to learn how to trade stocks, understand that simplification is neccesary when investing. However, you do not want to simplify to the point where you stick all your money in one fund. You need to be TRUELY diversified among multiple asset classes. I don’t mean that in the sense that you buy 10% of all materials 5% utilties, 10% consumer goods etc. That’s all great and everything when you consider the percentage of your investment capital that’s alocated towards stocks.
I mean across all asset classes.
Stocks
Real Estate
Bonds/Currencies
Commodities
(Internet)
Gold could almost be seperate from commodities, real estate could almost not be mentioned as they are heavily tied to the interest rates and economic growth. Bonds could potentially be seperate from currencies, and when I say investing in the internet, that’s basically investing your time or money into building your own website. You could say the same thing about your own MLM business or whatever, I just think the internet is the most reasonable that anyone can do. Google for example paid it’s publishers a total of some number that was in the billions with a B. That certainly is tied to the global economy.
That’s just one way to break it down.
So how do you keep it simple?
index ETFs.
So for stocks you could just own an S&P index fund. However I think some amount of hedging is neccesary, so maybe you have an inverse ETF in a specific area, and a regular ETF in another.
Real estate -own your own home or start saving up. You can designate a portion of your savings towards real estate. Even if it’s in cash this really shouldn’t count towards your cash allocation as that’s designed to be liquid and reused to buy stocks in other areas.
Commodities Gold and energy. Energy you could buy EEO, gold you could buy GLD
Bonds/Curencies – you can buy bonds, you can have cash on the side, and you can own currency etfs. Austraila or Canada.
With that in mind, consider a diversification strategy that has the following asset allocation.
30% to stocks asset class with substantial portion in inverse ETFs
10% Bonds mostly short term
15% gold
15% energy and other commodities carefully selecting those that benefit from growth in major emerging markets.
30% currencies (betting against the dollar, but not in the euro or a country with oversized deficit). Says best currencies are those that bennefit from emerging market like aussie dollar and canadian dollar. That will give you a dynamically diversified asset allocation of multiple asset classes and will protect you almost regardless of where all the money in the world flows to next.
How To Trade Stocks by Diversifying Your Investments
Trading stocks with a diversification method means that you will need to understand how to buy stocks and sell stocks without upsetting the balance of your portfolio. First you will want to decide what sort of balance you will have. A simplistic example may be a stock market diversification of:
Financial: 10%
Technology: 10%
Healthcare: 10%
Service: 10%
Consumer Goods: 10%
Industrial Goods: 10%
Basic Materials: 10%
Utilities: 10%
Cash: 20%
Again just to reinforce the difference, the percentages listed above are not an example of asset allocation. The true asset allocation of this strategy would be 80% stocks 20% currencies This is not necesarily a bad asset allocation, but if you chose one such as this, you must be properly diversified, and that means having a sector allocation like the one above. Many people will refer to stock allocation as asset allocation, and while technically that may work for some people, personally when I think of assets, I think of diversifying among multiple classes of assets. Now the question is how do you trade stocks? Well now that you have your parameters set, you need to figure out position sizing. It’s perfectly fine to have one individual company in each of the sectors mentioned, however every position you buy should be 1 or 2% of your portfolio. This means if you want to buy 1 stock in each sector, you should try buying stocks incrementally.
How to buy stocks – buying stocks online one at a time
Stocks should be bought one at a time until you are more experienced. You should buy stocks online at a given stock price. I say online, because that’s what I’m used to, but you can apply it offline as well. So say you have $100,000. After researching, you find out that you want to buy a stock that happens to be $40 per share. So you would buy $2,000 worth, or 50 shares. Now you have to consider your trading system or investment strategy to determine when you should buy more. Many people believe in averaging down, others belive in averaging up. It really depends on your time perspective and your system trading style. A value investor would recognize that the stocks volitility allows the investor to get undervalued stocks every time it goes lower. A technical trader, or momentum investor might see an increase as a show in confidence that the stock is gaining momentum. For the sake of this article, lets say you are a value investor. A value investor would then set a limit order for another 50 shares or so at a price of $38. The stock may dip and allow the investor to buy more shares. Now the value investor would have roughly 4% of his or her investment allocated towards this particular stock. The trick in how to trade stocks with diversification is to continue to build up your portfolio until it is diversified first. Lets say that the stock drops to 35, then $30. Lets say that the investor has purchased stocks in all stock sectors. The stock trader may now have a balanced portfolio for awhile, but after 3-4 months the investor should evaluate his positions. Lets say his portfolio now looks like this
Financial: 25%
Technology: 5%
Healthcare: 10%
Service: 5%
Consumer Goods: 10%
Industrial Goods: 10%
Basic Materials: 10%
Utilities: 5%
Cash: 20%
Now this is a problem albeight it can often be a good problem to have. Although you want to give your winners a chance to run, you don’t want to allow them to offset the balance of your portfolio. Some investment tip are usually mentioned here about buying stocks. Many say that the way to trade stocks is to rebalance your portfolio so that your asset allocation of stocks is balanced according to your parameters of diversification. If money in the stock market rotates sectors you are safe. However, the problem here is that if everyone that owns and buys stocks decides they want to allocate their finances so that they have more money in cash, bonds, and gold, the stock market may still crash even though you are diversified. There are two solutions to this. The first is if you should decide you want to focus on learning how to trade stocks. If this is your decision, you will need to hedge your investments, by shorting stocks. The other is to diversify among various asset classes. If you are going to learn how to sell stocks as well as buy stocks, you will need to start buying stocks as the markets are going lower, and start shorting as the markets go higher. There are a couple investment tips on hedging. One trick is to do fundimental analysis to determine which companies are overvalued and undervalued, or overbought and oversold, and buy the stocks that are worth more than they’re priced at, and sell those that are worth less than they’re priced at. Another trick would be to use technical analysis to analyze who is buying and selling, and to buy at buy points before the big institutions take over and drive the price higher, and sell before the big institutions can dump all of their shares.
In conclusion you can learn how to trade stocks if you understand the principals of asset allocation and diversification. You should be able to use these to safegaurd your wealth and gain wealth. If you follow the investment tips given, you will have the fundimentals down, as you learn how to trade stocks online and improve as a trader.
Recent Comments