PORTFOLIOS

Portfolios are one of the most important aspects of any investmentventure. This age-old concept has been applied to every facet of investingfrom mutual funds to real estate. It is as old as money. Aportfolio simply means not placing all your eggs in one basket. If youhave $100,000 to invest, you don’t put the entire amount in IBMstock. Or into another mutual fund. You divide the amount up andplace each segment in a different market or type of market sector.The reason for this is best stated in the Bible:Two are better than one; because they have a good reward fortheir labor. For if they fall, the one will lift up his fellow: butwoe to him that is alone when he falleth; for he has not anotherto help him up.Ecclesiastes 4:9-10Diversification is a way to deal with this potential for failure. Youdivide the risk so that if one investment fails, the possibility existsfor another one to pick up the slack or at least ease the blow.In the arena of speculative trading whether that be in options, futures,commodities, or stocks, the same principle applies, if not moreso. There are brokerage firms out there that will sell a novice traderon one market or another for one reason or another. Heating oil is oneof the more popular markets that brokers push during the early fall.The argument is that winter is coming and the demand for heating oilshould rise. As the demand for the market rises, so will the price. Becauseit is a logical, sound argument, people buy the pitch and thenend up buying the market. Most brokerages that sell this pitch do sothrough options. That way, if for some reason or another, the marketmoves against the position, the trader’s losses are limited to the purchaseprice of the option. Since the argument is so logical and therisks are absolutely limited, some will open up accounts for $10,000,$50,000, even $lOO,OOO+ and buy as many of those options as thatmoney will buy. They are gambling. Not trading a portfolio when it isaffordable is nothing but gambling. Some have lost the entire value oftheir account because the market went against them (and becausethey didn’t implement any money management principles).In this chapter, we analyze the benefits of creating portfolios intwo situations: trading without money management and trading withthe Fixed Ratio money management method. Both examples use leveragedinstruments. The benefits of trading a portfolio as opposed to asingle market or system without application of any money managementactually enhance the effects of applying the money managementto the portfolio. Market weighting, as discussed in Chapter 9, is a popularstrategy with many traders. However, this chapter demonstratesthat for the most part, they should not make it a common practice.