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 drops to daily lows near 1.1630
EUR/USD now loses some traction and slips back to the area of daily lows around 1.1630 on the back of a mild bounce in the US Dollar. Fresh US data, including the September PCE inflation numbers and the latest read on December consumer sentiment, didn’t really move the needle, so the pair is still on course to finish the week with a respectable gain.
GBP/USD trims gains, recedes toward 1.3320
GBP/USD is struggling to keep its daily advance, coming under fresh pressure and retreating to the 1.3320 zone following a mild bullish attempt in the Greenback. Even though US consumer sentiment surprised to the upside, the US Dollar isn’t getting much love, as traders are far more interested in what the Fed will say next week.
Japanese Yen refreshes three-week high vs USD; seems poised to appreciate further
The Japanese Yen retains bullish bias as BoJ rate hike bets offset dismal Household Spending data. Dovish Fed expectations fail to assist the USD in attracting buyers and keep a lid on the USD/JPY pair. Traders keenly await the US PCE Price Index for Fed rate-cut cues and a fresh directional impetus.
Editors’ Picks
EUR/USD drops to daily lows near 1.1630
EUR/USD now loses some traction and slips back to the area of daily lows around 1.1630 on the back of a mild bounce in the US Dollar. Fresh US data, including the September PCE inflation numbers and the latest read on December consumer sentiment, didn’t really move the needle, so the pair is still on course to finish the week with a respectable gain.
GBP/USD trims gains, recedes toward 1.3320
GBP/USD is struggling to keep its daily advance, coming under fresh pressure and retreating to the 1.3320 zone following a mild bullish attempt in the Greenback. Even though US consumer sentiment surprised to the upside, the US Dollar isn’t getting much love, as traders are far more interested in what the Fed will say next week.
Gold makes a U-turn, back to $4,200
Gold is now losing the grip and receding to the key $4,200 region per troy ounce following some signs of life in the Greenback and a marked bounce in US Treasury yields across the board. The positive outlook for the precious metal, however, remains underpinned by steady bets for extra easing by the Fed.
Crypto Today: Bitcoin, Ethereum, XRP pare gains despite increasing hopes of upcoming Fed rate cut
Bitcoin is steadying above $91,000 at the time of writing on Friday. Ethereum remains above $3,100, reflecting positive sentiment ahead of the Federal Reserve's (Fed) monetary policy meeting on December 10.
Week ahead – Rate cut or market shock? The Fed decides
Fed rate cut widely expected; dot plot and overall meeting rhetoric also matter. Risk appetite is supported by Fed rate cut expectations; cryptos show signs of life. RBA, BoC and SNB also meet; chances of surprises are relatively low.
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