Asset allocation

As you saw with position sizing, you can also decide how to allocate your money across various asset classes, also known as asset allocation.

Asset allocation is the way you divide your portfolio among asset classes, and it is the first thing you should consider when getting ready to trade or invest.

Below is an example of how you can do this.

What you can see in the picture above is an example of how you can allocate your money to different asset classes. Depending on your personal trading style, each of you can change the assets and the percentages, for instance by allocating 20% to currencies.

There are no good or bad allocations; you need to find the one that is right for you, based on your personal situation. It all depends on what makes you comfortable and gives you a good shot at meeting your goals.

Proper asset allocation allows you to diversify your portfolio, greatly reducing risks. Different asset classes tend to act in specific ways. By choosing how to divide your portfolio, you have a certain amount of control over all the possible adverse events that can affect the financial markets.

For example, allocating a portion of capital to commodities will allow you to protect the portfolio against a possible increase in inflation. Or, in periods of crisis that strongly affect the stock markets, investing in bonds, gold, the US dollar, the Swiss franc and the Japanese yen can keep you afloat, reducing (or eliminating, depending on the percentage of allocated capital) losses.

Let me tell you something. It is always important to have liquidity available, for a variety of reasons. First of all, for safety. For instance, the margins required by the broker might be raised, or a position may get into difficulty, so you must always have liquidity to deal with these situations. On top of this, you might come across some short-term trading opportunities, and it would be a shame if you could not exploit them.

As you have seen, you need to be strict with the stop-loss you decide on, whereas, in regard to asset allocation, you can afford to be a bit more flexible. A trade may use some of the liquidity that was originally intended for other assets.

The market will not always be the same, and this is why you have to use more assets. For example, there may be a period when it is a bit more difficult to trade options. As a result, you will make fewer option trades, using less liquidity for that asset.

Conversely, it could be a favourable time for currencies, with several excellent trading opportunities, and it would be a shame not to exploit them. So, moving small amounts of liquidity from one asset to another is an option.

In conclusion, it is important to allocate capital to different assets, in such a way as to always protect your portfolio, keeping it balanced.

Your allocation should be built on reasonable expectations for risk and returns, using diversified investments to avoid exposure to unnecessary risks.

Both asset allocation and diversification are rooted in the idea of balance. Because all investments involve risks, traders and investors have to manage the balance between risk and potential reward through the way they build their portfolios.