|
Diversifying the portfolio is the next rule of share trading. This is the old saying of don’t put all your eggs into one basket and means that you should spread your trading capital across a number of shares. To help understand this, consider the following 2 scenarios.
Case 1 – Our first investor invests his capital in only one company. The share price falls by 50%. Half of his trading capital is now gone. This trader is now playing catch up. The following capital recovery chart shows how much this trader must make on his next trade.
|
%
Loss From 1st Trade |
%
Profit needed in 2nd Trade |
|
10 |
11 |
|
20 |
25 |
|
30 |
43 |
|
40 |
67 |
|
50
|
100 |
|
60 |
150 |
|
70 |
233 |
|
80 |
400 |
|
90 |
900 |
|
100 |
Broke. |
Scanning down the first column to 50% you can see that the required profit in the next trade is 100% just to get back to his starting point. Profits on trades of 10% are common, but returns over 100% are more rare.
Case 2 – Our second investor invests his capital across 10 different shares. As with our first investor, 1 share drops by 50% while the other shares have not gone up or down in value. Our second investor still has 95% of his capital left even though he invested in the same share as the first investor. With 10 shares, the second investor has just 10% of his capital invested per share. With 1 of these shares falling in value by half, this investor has lost half of that 10%, or 5% of his total capital. With 5% lost, he still has 95% left.
There is risk in any investment you make. By investing across a number of shares, you will help minimise and manage that risk. |