Last evening, I was having a conversation with a fellow trader discussing the importance of asset classes as they relate to each other. Even though my friend is primarily a trader in stocks, he analyzes the futures markets for guidance and uses options strategies designed to help improve rate of return and to manage his risk.
Most investors and traders fail to recognize the benefits that related asset classes offer to the stock trader. We are incorrectly trained to believe that we will meet our goals focusing solely on the equity markets and diversifying our portfolio in different stock sectors. The truth is that no matter how many stock sectors you buy, they are all likely to fall when the markets crash. The only true diversification comes from holding different asset classes.
As you can see from the preceding chart, a diversified stock portfolio would have still lost money during the market crash of 2007. Traders and investors who diversified their portfolio in different assets, however, could have seen gains.
Benefits of Investing in Multiple Asset Classes
The other asset classes, such as futures and Forex, are beneficial for stock traders and investors in many ways.
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They can often offer a warning before the stock market changes direction and trend
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They can be used to hedge portfolios
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A portfolio comprised of stocks, futures and currency is properly diversified.
Forecasting the Markets
When looking for a forecast tool for the stock market, you need to understand the correlations between the stock market and several other assets. For example, as seen in the charts below, the market crash in 2008 and recovery in 2009 was preceded by turns in both the commodity and currency markets.
On a day to day basis, stocks will often react, and play catch up to, the equity futures markets. Futures trade nearly 24 hours a day and will act in response to news before the stock market opens. I have written about this before when discussing Program Trading. By understanding the futures markets, you can predict the morning movements and trading opportunities of the stock markets.
Hedging Portfolios
Since some currency pairs and futures mimic the stock market, a shorting position in these securities could be used to hedge the risk of a stock portfolio. Your gains in the short would offset the losses in the portfolio in the event of a market crash. There is a bit more that would need to be done to ensure the hedge is done properly, such as beta weighting the portfolio, but it is a strategy worth considering. Additionally, options on futures or indexes would allow you to create a hedge using less money.
Taking Advantage of Offsetting Rallies
Bonds, stocks, currencies and commodities all have differing cycles that they go through. Some are bullish while others are bearish. Creating a truly diverse portfolio of various assets can be a viable strategy to minimize risk in the event the market drops. Once again, diversification in different sectors is often just not enough.
We have discovered several reasons why having knowledge of multiple asset classes can be a huge benefit for the stock trader/investor. You can learn more about these assets at your local Online Trading Academy center.
Neither Freedom Management Partners nor any of its personnel are registered broker-dealers or investment advisers. I will mention that I consider certain securities or positions to be good candidates for the types of strategies we are discussing or illustrating. Because I consider the securities or positions appropriate to the discussion or for illustration purposes does not mean that I am telling you to trade the strategies or securities. Keep in mind that we are not providing you with recommendations or personalized advice about your trading activities. The information we are providing is not tailored to any individual. Any mention of a particular security is not a recommendation to buy, sell, or hold that or any other security or a suggestion that it is suitable for any specific person. Keep in mind that all trading involves a risk of loss, and this will always be the situation, regardless of whether we are discussing strategies that are intended to limit risk. Also, Freedom Management Partners’ personnel are not subject to trading restrictions. I and others at Freedom Management Partners could have a position in a security or initiate a position in a security at any time.
Editors’ Picks
EUR/USD stays in positive territory above 1.0850 after US data
![EUR/USD stays in positive territory above 1.0850 after US data](https://editorial.fxstreet.com/images/Markets/Currencies/Majors/EURUSD/money-euro-and-dollar-banknotes-17371247_XtraSmall.jpg)
EUR/USD clings to modest daily gains above 1.0850 in the second half of the day on Friday. The improving risk mood makes it difficult for the US Dollar to hold its ground after PCE inflation data, helping the pair edge higher ahead of the weekend.
GBP/USD stabilizes above 1.2850 as risk mood improves
![GBP/USD stabilizes above 1.2850 as risk mood improves](https://editorial.fxstreet.com/images/Markets/Currencies/Majors/GBPUSD/strong-pound-weak-dollar-17536259_XtraSmall.jpg)
GBP/USD maintains recovery momentum and fluctuates above 1.2850 in the American session on Friday. The positive shift seen in risk mood doesn't allow the US Dollar to preserve its strength and supports the pair.
Gold rebounds above $2,380 as US yields stretch lower
![Gold rebounds above $2,380 as US yields stretch lower](https://editorial.fxstreet.com/images/Markets/Commodities/Metals/Gold/gold-gm187363896-28836378_XtraSmall.jpg)
Following a quiet European session, Gold gathers bullish momentum and trades decisively higher on the day above $2,380. The benchmark 10-year US Treasury bond yield loses more than 1% on the day after US PCE inflation data, fuelling XAU/USD's upside.
Avalanche price sets for a rally following retest of key support level
![Avalanche price sets for a rally following retest of key support level](https://editorial.fxstreet.com/images/Avalanche/Avalanche_XtraSmall.jpg)
Avalanche (AVAX) price bounced off the $26.34 support level to trade at $27.95 as of Friday. Growing on-chain development activity indicates a potential bullish move in the coming days.
The election, Trump's Dollar policy, and the future of the Yen
![The election, Trump's Dollar policy, and the future of the Yen](https://editorial.fxstreet.com/images/Macroeconomics/Events/US%20Elections/Donald_Trump_closeup_XtraSmall.jpg)
After an assassination attempt on former President Donald Trump and drop out of President Biden, Kamala Harris has been endorsed as the Democratic candidate to compete against Trump in the upcoming November US presidential election.
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