Brandon Wendell, CMT
Brandon Wendell
Last evening, I was having a conversation with a fellow trader discussing the importance of asset classes as they relate to each other. Even though my friend is primarily a trader in stocks, he analyzes the futures markets for guidance and uses options strategies designed to help improve rate of return and to manage his risk.
Most investors and traders fail to recognize the benefits that related asset classes offer to the stock trader. We are incorrectly trained to believe that we will meet our goals focusing solely on the equity markets and diversifying our portfolio in different stock sectors. The truth is that no matter how many stock sectors you buy, they are all likely to fall when the markets crash. The only true diversification comes from holding different asset classes.
As you can see from the preceding chart, a diversified stock portfolio would have still lost money during the market crash of 2007. Traders and investors who diversified their portfolio in different assets, however, could have seen gains.
Benefits of Investing in Multiple Asset Classes
The other asset classes, such as futures and Forex, are beneficial for stock traders and investors in many ways.
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They can often offer a warning before the stock market changes direction and trend
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They can be used to hedge portfolios
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A portfolio comprised of stocks, futures and currency is properly diversified.
Forecasting the Markets
When looking for a forecast tool for the stock market, you need to understand the correlations between the stock market and several other assets. For example, as seen in the charts below, the market crash in 2008 and recovery in 2009 was preceded by turns in both the commodity and currency markets.
On a day to day basis, stocks will often react, and play catch up to, the equity futures markets. Futures trade nearly 24 hours a day and will act in response to news before the stock market opens. I have written about this before when discussing Program Trading. By understanding the futures markets, you can predict the morning movements and trading opportunities of the stock markets.
Hedging Portfolios
Since some currency pairs and futures mimic the stock market, a shorting position in these securities could be used to hedge the risk of a stock portfolio. Your gains in the short would offset the losses in the portfolio in the event of a market crash. There is a bit more that would need to be done to ensure the hedge is done properly, such as beta weighting the portfolio, but it is a strategy worth considering. Additionally, options on futures or indexes would allow you to create a hedge using less money.
Taking Advantage of Offsetting Rallies
Bonds, stocks, currencies and commodities all have differing cycles that they go through. Some are bullish while others are bearish. Creating a truly diverse portfolio of various assets can be a viable strategy to minimize risk in the event the market drops. Once again, diversification in different sectors is often just not enough.
We have discovered several reasons why having knowledge of multiple asset classes can be a huge benefit for the stock trader/investor. You can learn more about these assets at your local Online Trading Academy center.
Neither Freedom Management Partners nor any of its personnel are registered broker-dealers or investment advisers. I will mention that I consider certain securities or positions to be good candidates for the types of strategies we are discussing or illustrating. Because I consider the securities or positions appropriate to the discussion or for illustration purposes does not mean that I am telling you to trade the strategies or securities. Keep in mind that we are not providing you with recommendations or personalized advice about your trading activities. The information we are providing is not tailored to any individual. Any mention of a particular security is not a recommendation to buy, sell, or hold that or any other security or a suggestion that it is suitable for any specific person. Keep in mind that all trading involves a risk of loss, and this will always be the situation, regardless of whether we are discussing strategies that are intended to limit risk. Also, Freedom Management Partners’ personnel are not subject to trading restrictions. I and others at Freedom Management Partners could have a position in a security or initiate a position in a security at any time.
Editors’ Picks
EUR/USD climbs toward 1.1800 on broad USD weakness
EUR/USD gathers bullish momentum and advances toward 1.1800 in the second half of the day on Tuesday. The US Dollar weakens and helps the pair stretch higher after the employment report showed that Nonfarm Payrolls declined by 105,000 in October before rising by 64,000 in November.
GBP/USD gains ground above 1.3400 on UK PMI optimism
The GBP/USD pair gains momentum to around 1.3425 during the early Asian session on Wednesday. The Pound Sterling edges higher against the Greenback on the upbeat UK preliminary S&P Global Purchasing Managers' Index data. Traders will take more cues from the Fedspeak later on Wednesday.
USD/JPY dips as bearish pressure persists despite ETF growth
Ripple is finding footing above $1.90 at the time of writing on Tuesday after a bearish wave swept across the broader cryptocurrency market, building on persistent negative sentiment.
Editors’ Picks
AUD/USD hangs near one-week low; downside seems limited
AUD/USD trades with a negative bias for the fifth straight day on Wednesday, just above a one-week low touched the previous day, as a weaker risk tone and China's economic woes undermine the Aussie. However, the RBA's hawkish stance could limit deeper losses. Moreover, bets for more rate cuts by the Fed in 2026 keep a lid on the attempted US Dollar recovery, warranting some caution for bearish traders ahead of US CPI on Thursday.
USD/JPY dips as bearish pressure persists despite ETF growth
Ripple is finding footing above $1.90 at the time of writing on Tuesday after a bearish wave swept across the broader cryptocurrency market, building on persistent negative sentiment.
Gold extends the range play around $4,300
Gold edges higher during the Asian session on Wednesday, though it remains confined in a multi-day-old trading range. Dovish Fed-inspired bearish sentiment surrounding the US Dollar, along with the risk-off mood, acts as a tailwind for the safe-haven bullion. However, hopes for a Russia-Ukraine peace deal hold back the XAU/USD bulls from placing aggressive bets. Traders also seem reluctant ahead of the crucial US consumer inflation figures on Thursday.
XRP dips as bearish pressure persists despite ETF growth
Ripple is finding footing above $1.90 at the time of writing on Tuesday after a bearish wave swept across the broader cryptocurrency market, building on persistent negative sentiment.
Ukraine-Russia in the spotlight once again
Since the start of the week, gold’s price has moved lower, but has yet to erase the gains made last week. In today’s report we intend to focus on the newest round of peace talks between Russia and Ukraine, whilst noting the release of the US Employment data later on day and end our report with an update in regards to the tensions brewing in Venezuela.
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