Building a portfolio when trading or investing is crucial for several reasons, mainly in terms of risk management. Therefore, we’ve dedicated a complete guide on portfolios to help you understand the value of diversification using a profitable selection of instruments and assets.
We’ll provide all the information you need to start building your own trading portfolio, from the absolute basics such as answering what a trading portfolio is to more applicable tips such as where to use the right strategy for diversification.
In This Guide
What is a Portfolio in Trading?
A portfolio is a collection of financial securities, instruments, and/or assets created for a specific person and purpose, either by the person himself or a broker or money manager.
There are really two main goals when using a portfolio. The main one is diversification with the intention to lower risk. They say that you shouldn’t put all your eggs in one basket, and investments are a perfect real-life example of why this is so important.
By spreading your investments across different instruments and markets, you improve your chances of avoiding massive losses. This is a very important concept to grasp and will talk more about diversification in the next section of this guide.
The second goal with using a portfolio is to improve your chances of making a profit. As you probably already know, financial markets tend to fluctuate individually. With a well-planned portfolio, you can make a profit from commodities while the stock market is slow, or cryptocurrencies when the price of gold stagnates.
Diversification with a Trading Portfolio
As mentioned before, diversification and risk management is the main reason that you should build a solid portfolio. Diversification is the concept of buying multiple assets and instruments in different markets to avoid the risk of losing everything in case a certain market collapses.
Today, the most common instruments used for portfolio management are stocks, bonds, commodities, and some short-term investments. Lately, cryptocurrencies have become increasingly popular as a means of diversification.
In other words, the idea of building a portfolio is to hold and combine stocks, bonds, and exchange-traded funds with instruments such as gold, bitcoin, and even short-term CFDs and forex trading. Then, if the stock market collapses you can sell off your stocks at a potential loss without losing all of your invested money, or the other way around.
Also, many markets are dependent on each other. For example, when the stock market is tanking, many investors turn to gold which results in the value of gold increasing. Therefore, diversification doesn’t only protect you from potential losses but can also help you compensate for lost funds.
– Diversification and education are, by far, the two most important things to master in order to succeed as an investor or online trader.
How To Build a Trading Portfolio
There are certain golden rules when it comes to building your portfolio. For example, there is a graph that’s often used by beginners that want to minimize risk while fine-tuning the selection of financial instruments.
The graph, or model portfolio, says that a portfolio should consist of 50% bonds, 30% short-term investments, and 20% stocks. Obviously, this model can be adjusted in a million ways and is fairly easy to customize after your own needs. We also think it’s a really good place to start your first investment portfolio as it can serve as a solid base while you personalize your selection.
With that being said, the model does not fit everyone and there is an ongoing debate about which type of portfolio is the most efficient and how many percent of your budget you need to allocate to each type of instrument.
To better explain, we’ll walk you through some of the most common methods used to create investment portfolios.
What to Consider When Building a Portfolio
The purpose of creating a well-planned portfolio is to offset some of the risks involved with investments. Therefore, your aim is to find a selection of instruments that aren’t necessarily associated with each other. That way, if one investment fails and ends up a losing investment, your other investments will compensate for lost profits.
Now, as you can imagine, there are many ways to do this and several factors to consider. To help you get started, we have outlined some of the most popular strategies used for portfolio investments.
Create a Stock Portfolio
A stock portfolio is a very popular type of portfolio, although it’s not the most efficient solution to use for diversification. As the name entails, a stock portfolio is a portfolio made up of stocks.
The reason why it’s not considered an efficient solution for risk diversification is that the global stock market often acts as an entity, meaning that if the American stock market starts collapsing, chances are high that other stock markets follow suit.
If you still want to create a stock portfolio we strongly recommend that you pick stocks from a wide range of industries and markets in an attempt to offset the risk as much as possible.
A good solution could, for instance, be to buy a handful of American tech stocks, a handful of European industrial stocks, and penny stocks from an Asian stock market.
To learn more about Stock Brokers and Stock Trading Apps, please check our other guides.
Create a Mixed Portfolio
Due to reasons discussed earlier, a mixed portfolio is often the best way to go. It’s also a good strategy that allows you to benefit from several different markets at the same time while effectively lowering the overall risk of your combined investments.
Your objective is to find solid instruments to purchase in markets that are the exact opposites of each other. For example, a good selection of stocks from all over the world as well as a range of commodities. You see, when the stock market falls, commodities such as gold tend to soar in value.
However, depending on your strategy, budget, and investment plan, you can mix and match instruments and markets as you wish. If you’ve already invested in stocks, you can diversify your portfolio with cryptocurrencies, mutual funds, exchange-traded funds, indices, etc.
Just keep in mind that you have to analyze each market and instrument in detail to ensure that all your investments are sound and potentially profitable.
Making use of Portfolio Investments
If you – just like a large number of other investors – have been researching this topic, you’ve probably stumbled upon the term “Portfolio Investments”. And even though it’s almost self-explanatory, we thought we’d provide a quick explanation.
A portfolio investment is an investment that’s based on several instruments, similar to a regular portfolio only easier. In other words, it’s a way to invest in a good portfolio through a single investment. In turn, this saves you time otherwise needed to analyze several different markets and instruments. It’s also a good way for beginners with limited knowledge to limit the associated risks.
Even if this is a tried and tested method for risk management, we always believe that a tailor-made portfolio that you’ve created yourself is the best way to go since it gives you more control and the ability to benefit from the most profitable markets at any given time.
Moreover, portfolio investment is more passive than a direct investment that requires a more hands-off management strategy, making it perfect for those that want to make a profit from investments but that lack the time to be constantly monitoring a portfolio.
Read about the list of the best crypto brokers in the UK in our other guide.
What About A Portfolio for Short-Term Trading?
We receive a lot of questions regarding diversification and portfolios for short-term traders, ie. day traders and swing traders. And it’s important to understand that there are major differences between portfolios for investors and traders.
The most obvious reason for this is that you never keep your positions open long enough for a classic diversification to be useful. Instead, traders can hedge which means opening short-term positions on opposite markets to offset the risks of each position.
There are also several other risk-managing strategies that you can apply such as using stop-losses and always keeping track of all your positions.
With that being said, we do recommend that traders use some of their budgets to place long-term investments. By doing this, you can easily benefit from two types of trading while also limiting the risk of both.
Other Related Portfolios
To sum our guide up, we’ve written short descriptions of other strategies that can be used to build portfolios.
- A Defensive Portfolio – is a portfolio created with a defensive plan that aims to lower risk to a lower-than-standard overall risk but limited profitability. This method is all about being cautious.
- An Offensive Portfolio – is a portfolio created with the goal of being as profitable as possible, without limiting the risk too much. In other words, this method is all about increasing profits while offsetting some of the risks.
Related Articles:
One Reply to “How To Build a Trading Portfolio”
Leave a Reply
25,000 hours of testing 70+ brokers. Our recommended broker is Pepperstone.
Our recommended broker is Pepperstone.
Firstly, It the most important to choose an account that works toward your goals!