Quick and Simple Way of Creating a Perfect Portfolio To Reduce Our Risk Level

Although the purpose of portfolio theory is to distribute the risk by investing in different trading instruments, this topic, which has frequently come to the fore in recent times, is evaluated incorrectly.

In this article I will mention common mistakes of creating a portfolio and I will propose solutions. At the end of this article, I am going to present an example of a correctly diversified portfolio. Lets start with the common mistakes:

Common Mistake 1:  Using The Same Expert or All Our Trading Instruments

We can say quite clearly that creating a perfect portfolio from a single expert advisor is an almost pointless effort. Because, when creating a portfolio, not only trading instruments but also trading algorithms should be differentiated as well.

This is because in its core, expert advisors' decision making process is the same for all pairs.

Common Mistake 2:  Using Highly Correlated Forex Pairs In Our Portfolio

High swap rates and spreads create inefficiencies of trading minor forex pairs due to high costs. Therefore the general tendency among people is to trade commonly used currency pairs.

We can not create a diversified portfolio by trading both EURUSD and GBPUSD. This is because, when USD moves sharply, both pairs move in the same direction together. If we are using the same expert for both pairs, the expert will likely place the same buy or same sell orders for EURGBP and GBPUSD. In turn, instead of reducing our risk, the diversification will add up on our risk.

Therefore, in an ideal portfolio, we should use only EURUSD or GBPUSD. As a second pair we can choose a forex pair that does not involve USD.

For example, if we choose EURUSD, as a second pair we can choose AUDCAD. As a third pair, we can select another independent pair from  EUR, USD, AUD and CAD.

For example we can trade NZDCHF as a third pair.

We can say the same thing for indices as well. We should not invest in SP500 and NASDAQ at the same time. Because these are highly correlated pairs.

Common Mistake 3:  Using Only One Type Of Instruments

There are many type of trading instruments like forex, commodities, metal,  indices, stocks etc.

In an ideal portfolio and to reduce our risk level, we should not trade more than 2 pairs for each trading instrument.

For instance, in our portfolio we can have EURUSD and AUDCAD as forex instruments. Then, ideally we should move on to another type of instrument, for example, we can trade gold or silver.  As a third instrument, we can choose indices like NASDAQ or DAX.

Summary and Example Portfolio:

In summary, there are three  "the rule of thumb" criteria in a perfect portfolio with diversified risk. These are:

1- Do not use the same expert for all trading instruments.

2- Do not use highly correlated pairs.

3- Do not use only one type of investment instrument in our portfolio.

An Example Portfolio

I have used:

Cipher Hybrid-HTF for trading Gold,

Cipher Chase for trading Silver,

Cybele Unbound for  Trading Nasdaq and

Secutor for trading DAX40.

So, I have 4 different pairs with 4 different expert advisors and I don't have more than 2 types of trading instruments.

When I analyzed the risk reward ratio, with a starting balance of 1k, I have reached at almost 13k in just 3.5 years with a max risk of 1k. This is the success of both experts and correct portfolio diversification. You can track the live performance of this portfolio from this link: Example Portfolio

You can ask me any question regarding portfolio diversification.

See you in my next article.

Evren Çağlar

Professional Trader & Quant Trader