We hear a lot about diversification in a portfolio, and sometimes it is misunderstood. Diversification is really just an aspect of asset allocation, which is how much of our funds we put in each of many directions. Spread betting, because of the leverage enjoyed, is an ideal financial vehicle for diversifying your account, and this applies whether you only spread bet, or you own equity in your portfolio too.
The idea of diversification is that any particular event, whether it is the banks crashing or energy soaring in price at signs of a shortage, will only affect your account in a small way. Your funds are placed in diverse directions that perform independently from each other. As an exercise, this is sometimes more difficult than it appears.
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Firstly, it's fairly obvious that if your trades or investments are in one market sector, then your account is not diversified. Say you split your funds between various financial houses and banks, on the basis that you expect them to perform better than the market in the next year, you could very well be right but you would not be diversified.
This points out one consequence of true diversification. It will never be as profitable as putting your money in the right industry for any time. The assumption is that you won't be right all the time in selecting the best industry, so inevitably sooner or later you will do worse than the market. Diversification is a type of insurance against a catastrophic loss, and in common with conventional insurance contracts, diversification will cost you some money. This is the price of being more secure in your holdings.
Secondly, many markets are interrelated. A rise in energy costs is often associated with a fall in the shares of the airlines. The Nikkei 225 index is usually strong when the yen is weak. The Australian dollar and gold prices seem to go up and down together. Sometimes there are reasons for these relationships that can be understood, and other times they are just simply observations. But if prices are related, then the portfolio is not truly diversified. Even though in this case some relationships are inverse, diversification requires that as far as possible there is no relationship between the financial instruments.
Note the following points about diversification -:
Apart from spreading the risk, diversification provides different sources of income or capital growth. When one is doing well, another may be flagging, but on the whole the profits will average out to give a steady growth. The fact that you have more than one type of investment, and your account is diversified, means that there will usually be a sector making good progress to make up for the laggard.
You may think that you do not want to be invested in each of the market sectors most of the time, as sometimes they are in a downtrend. With spread betting, this is no problem. You can still take a position in a sector but it would be a short position, expecting to profit from a loss in value in the index or share. So a well diversified and profitable portfolio is almost always attainable, but needs to be thoughtfully considered.
>> Spread Betting: Realistic Expectations