Among the several reading materials that you have read about CFD Trading, you may have noticed that there is a common denominator in their discussions. More often than not, these reading materials talk about risk management, balancing portfolio and hedging of accounts. Where do the writers of these reading materials get their basis for stating that these tips prove effective to your trading account? Today, we shall clarify the main root why a lot of financial trading experts and coaches suggest hedging and portfolio diversification. We bring you 5 facts regarding Modern Portfolio Theory (MPT)
Fact 1: Modern Portfolio Theory is also called Mean Variance Analysis.
This financial theory states that traders seemingly wish for long term returns as they continue their trades. In order to obtain such a goal, the believers of this philosophy should never solely invest in extremely risky short term investments.
Fact 2: MPT also states that investing in more volatile and risky markets is hazardous to our trading accounts but because of their undeniable strengths, traders are still tempted to try them.
In order to help solve this dilemma, MPT suggests that traders are not prohibited to take part in risky markets for as long as they should observe hedging and portfolio diversification to balance the profit and loss flow.
Fact 3: A Nobel Laureate recipient developed the MPT theory.
Harry Max Markowitz, an American Economist who is also a John von Neumann Theory Prize (1989) and Nobel Memorial Prize in Economics awardee in 1990, developed the theory. Markowitz biography tells us that he is a notable advocate of modern portfolio theory, studying the effects of asset risk, return, correlation and diversification on probable investment portfolio returns. During his retirement in the field, he pursued his passion to share his expertise in wealth management by means of educating his fellow retirees via guided spending.
Fact Number 3: The Modern Portfolio Theory encourages traders to apply buy-and-hold strategy with occasional rebalancing.
With its name, it is very obvious that the buy and hold strategy advocates a long term hold of purchased stocks. Explaining further, buy-and -hold strategy states that a trader should keep holding onto his stocks despite erratic market rate movement. Thus swing trading is discouraged.
Fact Number 4: There are two strategies involved in the practice of MPT.
Strategic Asset Allocation and Two-Fund Theorem are the two strategies that adhere to the Modern Portfolio Theory. The former strategy teaches a trader to passively trade while the latter explains that individual stocks trading is not advisable.
Fact Number 5: The Modern Portfolio Theory is also applied in CFDs
Despite the risks involved with CFD trading, traders can still use the instrument to hedge over their portfolio. One of the best reasons experts suggest CFDs for hedging is because of the advantages that it can bring in terms of profits and returns.
The MPT is undeniably advantageous towards increasing profits and returns but its critics say that the theory itself is merely rooting itself on historical assumptions and it is not a hundred percent accurate in the modern market. To end our discussion, the trader is advised to weigh both the pros and cons of MPT before finally deciding to apply it in your trading practices.