Why Diversification Works In The Stock Market
Firstly I would like to say hi to all – this is my first post on Bloggertone – I hope to provide you all with some uniques insights on stock market investing and trading over the coming weeks, months and years. I am the MD of Share Navigator and we provide support services to stock market investors in an easy to understand – jargon-free way.
In this blog post I want to briefly explain why diversification in the stock market works. Most retail investors have heard that you should not put all of your eggs in one basket. But I wonder how many actually understand why? I will not bombard you with the mathematical formulas and standard deviations in explaining the ‘why’. I will explain in basic English – why diversification works. I have also attached a brief video for you perusal.
The bottom line is this – stocks do not move exactly together, on any given day stock A may go up while stock B may go down. By having more stocks in your portfolio you are reducing the ‘unique risk’ associated with individual companies. Stocks which are negatively correlated (stock prices move in opposite directions) give you better diversification: e.g. Airline Stocks and oil prices are negatively correlated. When oil prices go up airline stocks usually go down because they have higher costs associated with running their business (unless they have hedged their risk to adverse oil prices).
Stocks which are positively correlated (i.e. stock prices move in the same direction) do not give you the same diversification benefits e.g. AIB and Bank of Ireland. If you invest your money into banking stocks it is likely that they will go down and up together depending on market conditions.
In our video we give you a number of examples as why diversifcation works – I hope you enjoy and would love to receive any feedback .
Please leave comments after you have watched the video