The Hindu Business Line : Time diversification

ONE OF my friends has been trading in equity for more than 20 years. A person who has been at it that long typically tends to become over-confident. This can lead to bad trades. My friend practices time diversification. He believes that this approach prevents him from overtrading and hence reduces bad trades. What is time diversification?

Suppose you want to construct a portfolio worth Rs 25 lakh. You decide to allocate Rs 10 lakh for 5-7 -day holding period, Rs 5 lakh for 1-3-month holding period, Rs 7 lakh for 1-2 year-period and Rs 3 lakh for intra-day trading. This process of holding stocks with various trading horizons is time diversification.

How does this approach reduce your urge to overtrade? Overtrading essentially means trading frequently without necessarily generating higher profits. In fact, overtrading can be harmful to the portfolio as it could lead to more mistakes and, hence, higher losses.

We overtrade when there is an overwhelming urge to generate profits frequently. Time diversification helps curb this. The urge to generate frequent profits can be satisfied through a small capital allocation for intra-day trades. Moreover, making profits periodically in stocks held for 5-7-day period and 1-3-month period ensures that success comes at regular intervals. There is, hence, less desire to overtrade.

Time diversification is different from normal portfolio diversification. In the latter case, you may buy 10-15 stocks for Rs 25 lakh, all with even same holding period at times. The objective is to reduce risk of investing too much in a single stock.

Time diversification essentially ensures that a portion of your portfolio generates income through short-term trades while the balance earns handsome gains over a longer term.

(The author is Head, Research, Navia Markets.)

More Stories on : Stock Markets | Simple Economics

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page