Last night I heard a trader say something interesting. He said that people often come to the foreign exchange from a beginning of trading stocks (like me) and they have an idea stuck in their minds regarding diversification.
However in the Forex, thinking that you have diversification by trading multiple pairs can be an illusion because they are interrelated and quite often move in sync. This is obvious, right? So if you are applying one system to multiple pairs thinking you have diversification and thus lower your risk, quite probably this is an illusion.
At its most ridiculous, imagine this scenario - your one super system tells you to sell the GBP/USD and the EUR/USD, and buy the USD/JPY and USD/CHF...
Four trades, four pairs, four signals. In your mind you are diversified. BUT what you have actually done here is buy the dollar, buy the dollar, buy the dollar, AND..... buy the dollar!
It's virtually the same trade just upside down on two pairs. If the market decides that day that it hates the dollar, all your trades go wrong.
This trader said as an alternative to trading highly correlated currency pairs was to trade ONE PAIR using multiple systems, and this will give you adequate diversification.
I just never thought of it that way before, but it is obvious.
Thursday, May 10, 2007
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1 comments:
It's not quite as black & white as that because different symbols have different correlations on different timeframes, also different systems may have tendencies to trade in the same place. I would say one system on a handful of the least correlated symbols is best, it's hard enough trading one idea let alone multiple.
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