There’s a common misconception I hear repeated over and over again from “investor” types.
The other day I heard a guy on CNBC say “You need to diversify to succeed in the stock market.”
Nonsense, here’s the truth…
Diversification is for long-term investors. (Even that is debatable, but more on that later…)
On the other hand, traders can actually get hurt by spreading themselves too thin.
Today, I’ll tell you why diversification is overrated for traders and break down why the general consensus is wrong.
Keep reading and I’ll show you…
The Problems with Diversification
If you’ve ever watched financial news media or read a book about trading, you’ve probably heard about the (alleged) importance of diversifying your holdings.
If you’re a set-it-and-forget-it index investor, this advice might be better placed.
If you aren’t actively trading or investing, taking a more passive approach, and saving for your future, it’s fine to diversify and tune out.
But if you’re reading this, you’re not interested in long-term, passive investing. You want to be a great trader, and I don’t blame you!
And for traders, diversification is actually an incredibly dangerous game. Here’s why…
You’re Forced to Focus on Too Many Positions At Once
Short-term trading requires much more attention than passive investing. And this is even more true in the options market…
If you aren’t watching your active trades closely at all times, the chart could make a left turn when you turn your attention away, causing you to take a big loss (or miss the perfect exit).
Furthermore, if you diversify as a trader, it’ll be hard to keep your attention on the plays that matter most.
And this is exactly why I’m constantly preaching the importance of trading the best setups only!
You Can’t Get Aggressive on Perfect Setups
Join me for a hypothetical…
Let’s say you’ve diversified your trading. You have five open positions, each making up 20% of your portfolio…
Then, in the middle of those trades … an even more ideal setup comes across your screen.
Your capital is tied up, so what do you do?
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You’ll have to make a decision … cut the trades you’re already in to enter the new setup, or miss the intriguing five-star play entirely.
This isn’t ideal. It would be much better to avoid the five so-so trades entirely.
A Billionaire’s Gripe with Diversification
Don’t just take it from me. Billionaire trader Stanley Druckenmiller has his own thoughts on diversification…
“When I’ve looked at all the investors (that) have very large reputations — Warren Buffett, Carl Icahn, George Soros — they all only have one thing in common.
And it’s the exact opposite of what they teach in a business school. It is to make large concentrated bets where they have a lot of conviction.
They’re not buying 35 or 40 names and diversifying.”
According to Druckenmiller, even long-term investors should reconsider diversification.
If you want to master trading, you have to see the great setups and pile into them aggressively.
Here’s the deal, Evolvers…
Passive investing is the easy route. If you wanna make normal returns, simply buy an index fund and forget about it.
But, as one of my students, I hope your goals are loftier than normal returns.
I never would’ve been able to turn $50,000 into $4 million+ over 10 years by investing in index funds.
And to make extraordinary gains, you must exercise extraordinary skill and discipline.
This is why 90% of traders fail. It’s extremely difficult to have the conviction to put all of your eggs in one basket.
But that’s what the absolute best traders do. They see the big picture and execute flawlessly on the most promising opportunities.
Bottom Line: Don’t throw darts. Be a sniper.