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Diversification, and why four trades can be one bet

Spreading money across more positions is not the same as spreading risk. A portfolio of six markets that all fall together is concentrated, whatever the account summary says.

6 min read

Rows of seedlings of several different species growing in a wooden propagation tray
Different things, in the same soil, in the same weather. Variety is not always independence.

Diversification is the one piece of investing advice everybody has heard: do not put it all in one place. As a principle it is sound and as a practice it is routinely misapplied, because the thing being counted is usually positions rather than risks.

Owning ten things is not diversification if the ten things respond to the same event. And for anyone using leverage, the failure mode is sharper than it is for an investor: correlated positions do not merely fall together, they consume margin together.

Two portfolios that look equally spread

Both hold several positions. Only one of them has actually distributed anything.

Three holdings, one bet

50% in one technology company, 30% in a second, 20% in a third.

Three names, so the account shows three positions and no single company decides everything.

All three respond to the same interest-rate expectations, the same sector sentiment and the same handful of earnings seasons. A repricing of technology valuations moves all of it at once.

Six holdings, several bets

30% US shares, 20% international shares, 20% government bonds, 10% corporate bonds, 10% gold, 10% cash.

Also capable of losing money, and in a genuine crisis several of these can fall together. Correlations rise exactly when you would like them not to.

But no single company, sector or country determines the outcome, and the components respond to different things most of the time.

Correlation is the thing being measured

Two positions are correlated when they tend to move together. Perfectly correlated positions are, for risk purposes, one position held twice. The useful question about a portfolio is never how many holdings it has - it is what single event could move most of them in the same direction on the same afternoon.

The honest answer is usually less comfortable than the position count suggests.

The same pattern appears everywhere once you look for it. Several technology shares are one bet on the Nasdaq. Gold and silver move together far more often than not. A basket of cryptocurrencies is overwhelmingly one bet on crypto as an asset class, whatever the individual projects claim to do. Oil, energy producers and the currencies of oil exporters share a driver.

This is why position sizing has to be done at portfolio level rather than one trade at a time. Five trades at 1% each are only five separate 1% risks if they are genuinely separate.

Leverage changes the failure mode

For an unleveraged investor, correlated holdings falling together produces a bad month. For a leveraged trader it produces a margin problem, because every position draws on the same equity.

Six leveraged positions across six markets are not diversified if the total exposure is large relative to the account. What matters is the aggregate: total market exposure against equity. Opening more markets while raising that ratio has increased risk while feeling like it reduced it.

The mechanism is set out in margin explained; the short version is that correlated losses drain free margin at several times the rate any single position suggests.

There is a point where more stops helping

Adding holdings reduces concentration risk quickly at first and then barely at all. An investor already holding a broad index fund of 500 companies gains almost nothing from a second fund holding many of the same 500. Five global equity funds are not five times the diversification of one.

Past that point the additions bring costs, complexity and the comforting illusion of having done something. The goal is not to own as many things as possible; it is to avoid depending on any single source of risk.

What broad access actually looks like

Diversifying across asset classes requires a broker that offers them. Most forex-first brokers cover currencies, indices, commodities and a handful of share CFDs; genuine breadth - real equities, bonds, funds, futures and options alongside the leveraged products - is rarer, and it tends to come from the older, more heavily regulated firms.

Five brokers in our records list eleven or more distinct market types.

The broadest asset-class coverage among the hundred brokers we rate, in rating order.

Breadth is one measure and not a recommendation. Several of these are more expensive or more demanding than a narrower broker that does one thing well.

Using two brokers is a different kind of spreading

Holding the same portfolio at two brokers does not diversify the portfolio - the underlying exposure is identical. What it reduces is your dependence on one institution: one platform outage, one withdrawal freeze, one firm failing.

Compensation arrangements complicate this in both directions. Some jurisdictions protect eligible client assets up to a limit if a regulated firm fails, and spreading across firms can affect how much falls inside those limits. But eligibility depends on the country, the legal entity, your client classification, the type of asset and the nature of the failure - so opening a second account does not reliably double anything.

The figure that matters is the one attached to the specific entity holding your money, which is not always the entity named on the website. Each of our reviews records it.

What it cannot do

Diversification reduces the risk of being wrong about one thing. It does not remove market risk, recessions, inflation, interest-rate moves, illiquidity, currency risk or a systemic crisis, and in a severe one correlations across almost everything rise at once.

It also cuts both ways. The concentrated portfolio that halves when its one holding fails is the same portfolio that doubles when it succeeds. Spreading risk means accepting a narrower band of outcomes in both directions - which is the trade being made, and it should be made deliberately.

Questions people ask about diversification

Is owning ten stocks diversified?

It depends entirely on which ten. Ten companies across unrelated industries and several countries is meaningfully different from ten US technology firms, and the position count is identical.

Can you be too diversified?

You can reach a point where more holdings add cost and complexity without reducing risk - particularly when several funds hold many of the same underlying companies.

Does diversification work for forex trading?

It can, but currency positions are unusually prone to hidden correlation because so many pairs share a currency. Four pairs quoted against the US dollar are largely one dollar view.

Does holding more positions reduce my margin risk?

No. Every position draws on the same equity, so what matters is total exposure against your account, not how many tickets it is split across.

Does diversification guarantee against losses?

No. It reduces dependence on any single investment. A diversified portfolio can still fall substantially, and in a crisis most of it can fall at once.

Is using two brokers diversification?

Not of your investments - the exposure is unchanged. It reduces reliance on one institution, which is a different risk and a real one.

What is the difference between diversification and asset allocation?

Asset allocation is how much goes into broad categories such as shares, bonds and cash. Diversification is the wider practice of spreading exposure across sources of risk. Allocation is one part of it.

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Nothing here is financial advice. Leveraged products can lose more than they make.

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