top of page

From Stock Trading, Investing, and Option Trading: The Role of Diversification in a Portfolio

We've all heard "don't put your eggs in one basket!" I take the same approach with my trading and investing. As an experienced trader, I know that diversification is an essential tool for managing risk. Just like you wouldn't put all your eggs in one basket, you don't want all your trades to be in one sector, industry, or geographic region. As Warren Buffett famously said: "Diversification is a protection against a single event wiping you out."

To diversify your trades, you need to spread them across different sectors, industries, and geographic regions. This approach reduces your exposure, making it easier to manage risk. However, diversification doesn't eliminate all risks, as a rising or falling tide can lift or sink all the ships. Still, by diversifying you can avoid putting all your trades in tech companies, for instance.

In addition to diversification, I combine other strategies like mean reversion, buy low/sell high, and seasonality to create a trading and investing system to determine when I should enter and exit the sector, industry, or region. When a sector/industry/region has made a significant move up, I take some profits or close my position altogether. I don't have to catch the entire move to make good amounts of money. When a sector is getting beat up and the experts are all negative, and there is fear, I start buying and finding bullish trades. I like to trade travel stocks going into the spring and summer, energy stocks in the winter, and agriculture into the spring (harvest season).

Of course, not all of these strategies work all the time. I give my trades enough time to revert to the mean or work out. If I have to take a loss and cut losers, I will. Since we talk about trading small and trading often in the GKT community, I've mitigated my risk through position size. When retail is doing poorly, my other sectors should balance out the loss.

The drawback with diversification is that blindly diversifying can result in lower returns. You'll essentially become a mutual fund, with too many positions, and your winners and losers will cancel each other out one for one.

To maximize your returns while minimizing your risks, I suggest you get familiar with a few sectors and a couple of seasonality plays that you understand and are comfortable tracking and studying. Know and understand the support and resistance levels, track the fundamentals of the companies, and monitor the volatility and liquidity of the underlying assets. Then, build a plan on how you want to trade and execute it.

For example, when you see a massive rotation out of healthcare (XLV), and stocks you like start getting to support or even breaking through support, start buying them! It's scary buying when everyone else is selling and running away, but this has worked well for me. Find sectors, industries, regions you like and understand. Draw out your support and resistance levels, understand how the sectors work, what's good for them, what's bad for them, and combine math-based principles of probability and volatility to your advantage!

When the big market players start making rotations, the moves get exaggerated, and as tiny retail traders/investors, we don't have control over the movement of the market. But we can use diversification and the other strategies we teach here at GKT to our advantage. As Buffett noted, "The stock market is a device for transferring money from the impatient to the patient."

Don't be afraid to take some risks, but diversify across a few sectors/industries/regions to help even out your profit and loss during significant market moves.

If you want to learn more about how I diversify in life you can check out my blog at Playbook to Freedom

If you're interested in joining a community of traders and learning more about these strategies, consider joining Good Kids Trading (GKT) by clicking here.

19 views0 comments


Brown Modern Coffee Shop LinkedIn Banner
bottom of page