Perhaps the most critical feature of any money management strategy, diversification refers to spreading the risk in the Forex trading account or portfolio. The spread isn’t random.

Instead, it considers all possible factors, micro, and macro, that affect the potential of a portfolio. Moreover, it considers all the likely costs too.

Think of the big hedge funds and investment houses for example. Retail Forex trading can’t compare with this size of the business but in one aspect: the way to manage the trading account.

The “big guys” job is to “navigate” turbulent times in such a way to protect the value of their investments and to make some money. Believe it or not, the main aim isn’t to make money. Instead, the focus is to protect the capital.

A money manager that ends the year up one percent is perceived as a loser when the average return on the industry exceeds, say, ten percent. Investors will flee, redemptions will rise, and the next thing you know the fund will close its doors.

The same money manager, however, can be perceived as a hero, having the same return: one percent. Consider the industry has lost money on average, and only a handful of funds gained some. Hence, the job of protecting the capital was done successfully.

Diversification refers to the mindset too. Take, for example, contrarian trading.

Thinking the other way as the crowd isn’t necessarily wrong. In fact, it is quite an interesting setup: if almost everyone in the retail world loses money then why not finding an edge against it? Diversifying the mindset helps to reach that goal.

Diversification in Forex Trading

Contrary to the general belief, diversification begins before Forex trading starts. In fact, it starts from the reason that draws a person to the trading game.

If it is curiosity or the need for a hobby, this is an expensive place to find out. If it is adrenaline, the same applies.

But most people come to Forex trading to complement their income. To have an extra, another source of income than the regular one. Or, to diversify from depending on one income from the regular day job and securing another one.

Why put all of your eggs (e.g., earning potential) in the same basket, and not diversify, just to spread the options of making more? The same applies to any investment, like buying a house, etc., not only to Forex trading.

The first condition to make sure Forex trading doesn’t ruin your life is to control how much you risk. This can also be said for investing, fund a trading account, etc. The Internet is full with examples of traders endangering much more than they can loose, only because they didn’t know how to handle the market or had absolutely no idea about what Forex trading is. Not to mention the affects of greed and fear and their disastrous consequences for a trading account!

The proper economic terminology refers to this as investable assets. To find out what the amount is, don’t consider the net worth.

Instead, consider what’s left after deducting any asset that represents livelihood assets. Whatever’s left, that’s the sum to fund a trading account.

As you can see, the diversification process has already started. Next, it is time to focus on how to deal with the actual Forex trading account.

Maintain a Healthy Cash Position

It all starts with the cash position in a trading account. At first, it is one hundred percent, but that’s before the splitting of the portfolio into various parts.

Splitting considers all the possible markets to tackle from the same trading account.

One part should be cash. Ideally, the allocated proportion should vary in a bandwidth of about 15%-25%. How come?

The cash fulfills two roles:

• one is to provide enough margin for the trades that go against the desired direction. There’s still a distance the market needs to travel until the stop loss is reached, and that distance requires free margin. On multiple opened trades, that sums up to quite an amount.
• another is to use it for picking up opportunities. What’s the point if the market comes into a significant buying or selling point if you have no cash to take advantage of it?

Therefore, traders need an interval: the minimum should never be broken while the upper side of it can vary.

Cash is king and having no position is a position. Just because the market is open, isn’t a good reason to open a trade.

Mind the Dollar

As the world’s reserve currency, the dollar commands the lion's share in Forex trading too. In fact, it splits the Forex trading dashboard into two categories: major and cross pairs.

With that in mind, let’s split the remaining part of the portfolio into three equal parts. Why three?

Here’s why:

• one dedicated to trading majors only (a.k.a. currency pairs that have the U.S. Dollar in their componence)
• another one to trade crosses only (a.k.a. currency pairs that don’t have the U.S. Dollar in their componence)
• finally, one to trade something other than currency pairs. Forex brokers nowadays offer many other markets to take advantage of, with similar principles like Forex trading. Such markets are commodities (e.g., precious metals – gold, silver, etc.), indices, and even individual stocks; all offered in the form of Contracts for Difference (CFD). Traders have the possibility of trading them from the same Forex trading account.

Furthermore, the part dedicated to trading majors and crosses should be limited too. Depending on restrictions on the trading account (e.g., hedging), the diversification strategy suffers changes.

A simple rule is to avoid trading more than three USD pairs at the same time. And, the same with crosses.

Even though crosses do not have a USD exposure, for every cross two major pairs dictate its move. Hence, the dollar’s role still matters, but indirectly.

Conclusion

Obviously, this is not enough. While explaining the steps to diversify a trading account, it isn’t enough from a money management point of view.

Instead, it represents just a step of the overall trading strategy. Next, traders consider the risk involved, how to define it and how to make sure the reward exceeds it for every trade.

Moreover, the process of embracing losses is as important as the one of handling a winning streak. Hence, the psychological aspect of trading influences money management also.

Contrarian trading comes to give a competitive edge as diversifying from the regular way of thinking. Therefore, diversifying from the crowd, which almost always leads to better overall Forex trading performances.

Some of these aspects we’ve already covered, and the rest are still to come. If you find your trading style misses any of the issues mentioned here, then your money management system needs drastic improvement.