Portfolio optimization

Portfolio optimization is something that stock traders typically are more concerned with than other traders. However, if you are trading multiple markets, we should at least be aware of the general idea of portfolio optimization.

The idea behind optimization is to make a portfolio, or in other words the group of investments that you are participating in, perform better than random stocks. The rate of return is without a doubt the largest portion of optimization, but you also have to worry about efficiency, and of course other things such as transaction costs. Quite frankly, in the Forex world, transaction costs are built-in with the spread, just as they are in the CFD markets. However, there are a few things that I would mention as far as portfolio optimization is concerned.

Correlation is the biggest thing you need to be aware of. There are some assets that move together. For example, the Australian dollar tends to rise and fall with the price of gold. So if you were to go long the AUD/USD pair, and go long the gold CFD, you would be putting yourself at risk because both could fall at the same time and do quite a bit of damage. Ultimately though, what you can do is mitigate your risk of buying trading uncorrelated markets.

For example, you could buy the DAX CFD, while shorting the USD/CAD. These are 2 markets that have absolutely nothing to do with each other, and have very little in the way of correlation. The idea is that both markets can move in the direction you need them to, and not hurt you. Or, one could go in the right direction and the other one could fall against you, but over the longer term you should essentially “even out” when it comes to your returns.

This is a huge subject that takes a lot of study, but it is something you should be aware of. Look for the correlations between currencies and CFD markets, and learn not to overextend your portfolio and one direction by accident.