Portfolio Diversification
Overview
Portfolio diversification reduces risk by spreading capital across multiple uncorrelated or negatively correlated assets, strategies, and timeframes. True diversification requires correlation analysis — holding 10 tech stocks is not diversified. The goal is to generate returns from multiple independent sources rather than relying on a single trade or strategy.
Key Concepts
Asset class diversification: equities, bonds, commodities, crypto, real estate. Strategy diversification: trend-following, mean-reversion, carry, momentum. Timeframe diversification: intraday, swing, position trading. Geographic diversification: US, European, Asian markets. Correlation analysis: measure how assets move together.
Entry Signals
Allocate capital across 3-5 uncorrelated strategies. No single position should exceed 5-10% of total portfolio. Rebalance when allocations drift by more than 25% from target. Include both long and short strategies for true hedging.
Exit Signals
If one asset class dominates portfolio P&L (either direction), rebalance. Review correlations quarterly — correlations change during crises. Reduce exposure to asset classes exhibiting increased correlation during stress.
Best Timeframes
Portfolio-level decision — applies to the overall trading business
Pro Tips
Diversification reduces returns during optimal conditions for a single strategy, but dramatically improves risk-adjusted returns and survivability. During market crises, correlations often spike toward 1.0 — true diversification requires assets that change correlation behaviour.
More Topics in This Category
Kelly Criterion
The Kelly Criterion is a mathematical formula for determining the optimal bet size to maximise long-term growth rate. Kelly = (bp - q) / b, where b = odds received, p = probability of winning, q = probability of losing. While theoretically optimal, full Kelly is too aggressive for most traders — half-Kelly or quarter-Kelly is more practical.
Trailing Stop Strategies
Trailing stop strategies dynamically adjust your stop-loss level as a trade moves in your favour, locking in progressively more profit while still giving the trade room to develop. Unlike fixed stops, trailing stops adapt to market volatility and price action, allowing traders to capture the majority of a trend move without exiting prematurely on normal pullbacks.
Risk of Ruin Modeling
Risk of ruin calculates the probability that a trader will lose a specified percentage of their account — typically enough to end their trading career — given their win rate, average reward-to-risk ratio, and percentage risked per trade. This mathematical framework quantifies whether a trading strategy is survivable over the long run and helps traders set appropriate risk limits to ensure longevity.
Fixed-Fractional Position Sizing
Fixed-fractional position sizing risks a fixed percentage of your account on every trade (commonly 1-2%). This ensures that a string of losses reduces position sizes proportionally, protecting capital during drawdowns. It's the most widely recommended position sizing method for discretionary traders because it's simple, sustainable, and mathematically sound.