Almost everyone knows they should trade a variety of products to diversify their portfolio, but defining “diversify” seems to be tricky for some people. At its simplest, diversification means trading two or more uncorrelated products so that if one does poorly, the others typically will excel.
Kinahan illustrates this saying, “If I trade Exxon, then trading BP is not diversifying; if I trade 10-year notes, then trading five-year notes is not diversifying. It’s really trading something that’s in a different sector.”
An important aspect of diversification to remember is that it is not something you can do one time for your portfolio and never worry about again. Events in the world affect markets differently, and there are times that correlations between markets can change. A number of examples of this can be found, and “Strange bedfellows” (below) shows one instance when gold and the U.S. dollar, which normally are correlated negatively, developed a positive correlation in 2010.