October 2015 – Deep Thinker

In today’s global investment environment, equities, fixed interest or property from around the world is very accessible. bhp-rio This means 2 things – some part of the world will always be performing better than another and any investment has a true diversified alternative.

bhp-anz Diversification is measured by the correlated move of 2 investments – for example if BHP changes its value (up or down) there is a high probability that RIO will move in the same direction. So the 2 investments do not offer much diversification, they may vary a little but from the chart to the right similar issues will effect both companies.

A lower correlation would occur between BHP and ANZ being from different market sectors, but still the same fate may be born if the Australian share market is struggling.

A lower still correlation may be obtained with BHP and Microsoft.

An even lower still correlation may be obtained with BHP and Government Bonds or BHP and Property. Both of which have an extremely low correlation of a similar move.

So why is this important? — The object of diversification is to create a robust investment strategy that will not collapse if the wind is blowing the wrong way. The more assets you have in your investment portfolio that are moving in different directions the safer and more robust your investments will be. This doesn’t necessarily lead to a lower return, especially with the correct rotations and reweighting, but it does lead to safer investments.

One thing that determines what strategies you need in the market, is whether you are a Trader or an Investor. They both have a goal of making money, but the means at which they approach things is completely different.

An investor should consider his long term goals and structuring investments to achieve those goals. An Investor could be using fundamental information to determine the current value compared to the target value the analysts have on the asset. They may be buying on the way down, in the hope that proper value will return to the asset creating a capital gain. Owning a good quality company which has been under performing is often the goal. As an investor its important to look at asset allocation for diversification.

A trader will have a set of rules or triggers that cause him to act in the market. This may be very simple (like the crossing of a moving average) or very complicated with multiple rules and conditions. A trader will primarily be using Technical indicators to make decisions on the market.

As a Trader, your rules will determine the duration of your trades – with more aggressive rules, trades will be shorter in duration with faster entries and exits. With more conservative rules, entries and exits will be slower resulting in longer trade duration’s.

More aggressive conditions will trade more often, looking for smaller moves to take advantage of. More conservative conditions will trade less and require more evidence to enter (so will be slower). Its important to think that the speed of entry must match the speed of exit. Entering fast and not taking profit will lead to frustration, as will entering slowly and exiting fast. So entry and exit rules must be reasonably balanced. Think of a golf swing, a short back swing has a short follow through – a big back swing has a big follow through.

Traders and investors may also use different products to increase returns – options, warrants, CFD’s or futures increase gearing into investments as margin loans. As a rule of thumb, higher geared products are generally more suited towards traders than investors.

So which is right – that really depends on your mindset, your discipline, your confidence and your availability of information. Both traders and investors can be active in the market using very different strategies.

Whichever you are, make sure the strategies you use fit in with your goals.

Happy trading/investing 🙂

Month: October 2015

Diversify or Suffer the Consequences

Are you a Trader or an Investor ?