It is the division of your capital into parts and the distribution of these parts into different assets, the price of which reacts differently to market signals.
Many traders use diversification to reduce their capital loss risks on a single instrument. To use diversification, a portfolio of instruments is usually formed, which is regularly monitored and, if necessary, measures are taken to cut off unnecessary losses.
The development of smartphone applications has made the application of diversification very popular. People form portfolios of assets using applications like “Tinkoff Investments”, right on the go. On the one hand, this in some cases gives a positive result, on the other hand, such a method used by citizens is not quite qualified, because the methods of managing portfolios of professional managers in large banks are completely different.
An ordinary trader can manage the cut-off of unprofitable positions by setting stop-losses, i.e. actually closing their positions. A professional manager hedges portfolio positions by selling a counterweight, which, for example, grows when the underlying asset begins to fall in price. A kind of “swing” is made, excluding a loss for the time of applying such a strategy. Let’s explain by example an interesting way of using such a strategy with an example for the BINANCE exchange. On the BINANCE exchange, it is possible to trade separately on a spot account and on a futures account, which allows you to implement the following risk hedging strategy:
1) Let’s say you have $300. You buy a certain asset on the spot, for example, an ETH coin (Ethereum) for half of your amount ($ 150) in the hope of further growth.
2) Then the situation starts to become alarming, the price starts to fall more often than it grows, and you decide to stop it somehow. To do this, you log into a futures account and sell ETHUSD futures for $150.
3) Your fears were confirmed and then the coin on the spot immediately drops by 20%, but at the same time the short on the futures account gives 20% profit from the same amount. You didn’t lose anything in the end.
4) Then the clouds dissipated and there were signs of further growth. You close a deal with a profit on a futures account and immediately bribe the cheaper ETH on a spot account, earning already on a rapid growth.
An analogue of such a scheme on the MICEX may be the purchase of ordinary shares and their hedging by the sale of futures on these shares. However, given the different prices of these assets, the number of stocks and futures should be carefully selected to create a compensating effect.