Why You Shouldn’t Diversify Your Foreign Exchange Trading
If you have research investments and financial market trading you will often come across the advice to diversify. While this may be a good idea if you are investing over a number of markets if you are going to focus on foreign exchange then you should consider not diversifying. When you diversify on the foreign exchange market you increase the number of currency pairs you trade and the strategies you use. There are many reasons for why this is not a good idea.
The Capital of Diversification
When you look to diversify your trading you require more capital. The more currency pairs you are going to be trading the more money you need to open and hold the trades. The amount of capital that you need may be far above what you actually have on hand. You should never include money that you cannot afford to lose simply to diversity. In fact, a lot of successful forex traders only use one or two currency pairs for their trading. This also allows you to put more money into a single trade without exceeding your risk limits.
Time Needed for Foreign Exchange Diversification
Trading more currency pairs means more research and analysis must be done. This means that you have to divide your time up more amount all of the pairs. As there are only so many hours a day that you should be trading in you run the risk of not completing thorough analysis. When you are unable to complete analysis properly you are going to open bad trades and end up losing money.
You also have to think about the time it takes to plan your trades and the market conditions needed for different currency pairs. There are certain currency pairs that work well for trend traders while other pairs range more making them ideal for position traders. The best time to trade these pairs could be on opposite sides of the market. Diversification in foreign exchange trading can easily lead to overtrading because of the extra time needed to complete everything.
Your Trading Plan
When you create a trading plan you need to keep it simple. If you have to include all the conditions for all the different currency pairs you are trading the plan will no longer be simple. The more complex a trading plan is the more likely you are to divert from it and give into emotional trades. You will also have a harder time finding the weak points in your plan when it is complex.
When you have fewer currency pairs you can see if your trading plan works with the pairs and where you are going wrong. As currency pairs move differently to each other you reviewing of your trading plan could become harder. You may also find that your trading plan works for certain currency pairs and not others.
A Tax Nightmare
When you trade forex you need to consider the tax implications of everything you do. When you diversify your trading you create more trades and include more variables. This can make reconciling the accounts for tax purposes harder and more time consuming.