Global Macro Trading and the Benefits of Diversification

By Michael Howard

Most long time investors have heard that diversification is the only free lunch on Wall Street. If you have used a financial advisor to pick your investments for you, you may have been told you were diversified but the way it usually works out your diversification is weak at best and in some cases is almost non existent. Obviously you just need to learn the proper way to diversify.

The typical planner will have you put some of your money in domestic stocks, some in foreign stocks, and then place some money in bonds. If that is all you are doing you are not getting nearly the benefit you could be getting and in reality you are barely diversified at all.

When you are properly diversified you will be invested in all liquid asset classes and sometimes even a few that are relatively illiquid investments. In addition to being in several asset classes you will also be in several different types of strategies with multiple time horizons. Global macro traders have known for years that if you dont cast your net wide you will have a hard time performing in all market types. If you just have a bunch of global stocks then all your investments are extremely correlated which means when a few drop the rest drop. One of our goals as investors is to avoid that.

Global macro traders diversify into asset classes such as domestic stocks, foreign stocks, Treasury bonds, investment grade corporate bonds, junk bonds, foreign government bonds, foreign corporate bonds, commodities, real estate, and currencies. Some traders even trade in collectibles like art. Why do they cast their investment net so wide? For the simple reason that one asset class may be in or out of favor at any given time.

Global macro traders would all agree that one of the most important goals of an investor is to look for the best risk to reward opportunities. This is in stark contrast to most financial planners who just say buy and hold stocks for the long run. Yes, it can work for the long run but sometimes the long run is 30 years before you even see a positive return. Most of us dont live forever so lets plan accordingly.

Luckily we can diversify not only across asset classes but also across different strategies in each one. For instance if you could allocate some money to a long term value investing strategy that looks at three to five years out investing in stocks and then also invest in a good short term trading fund. By doing this you can capture slightly different types of alpha or excess return. If you build a portfolio this way you will become extremely diversified and uncorrelated to regular investments.

If you diversify wide and deep your investment returns will be far more consistent and in most years will be better off then the standard stock and bond mix that so many so called professionals push you into. There is no guarantee that you will make money every day, month, or even year but by following these concepts you can really improve your risk adjusted returns.

If you prefer to do all of this on your own then you will be well served to learn how to build or just buy several good models so that you can more easily track several asset classes. For instance you will want a few models for the stock market, a few for commodities, etc. The more efficient you set up the process the better your returns will be as you will miss less great risk to reward opportunities. - 23229

About the Author:

The Macro Trader does research for a newsletter that gives the Global Macro Trader actionable trading ideas each week. Mean Reversion is but one of the many strategies that we use to help find the best risk to reward opportunities across the globe.