Diversification, both in investing and trading, is a key principle of risk management. It is a strategy that involves distributing investments among different assets and instruments to reduce risks, hedge them, and also increase potential profitability.
The main goal of diversification is to distribute assets and risks in such a way as to create the best combination of assets and instruments with different yields and risk levels.
For example, we know that investments in new projects at the presale stage, such as IDO, can bring significantly higher returns than investments in the most common cryptocurrencies, such as Bitcoin and Ethereum, if the project takes off. However, the riskiness of such investments is also higher, as not all new projects will meet expectations. Meanwhile, investments in widely held assets will be more reliable, but their yield will be lower. Therefore, market participants may invest in new projects for potential high returns, and in major cryptocurrencies for profit stabilization.
The main rule of diversification is to include in your portfolio assets and instruments whose returns do not correlate with each other. Thus, if some news can affect your investments, it either affects part of the portfolio, does not affect it at all, or has the opposite effect on another part of the capital. As an example, during a general downturn in the crypto market, spot purchases will be in a slump, while if part of the capital is connected to automated trading, the algorithms will trade short in a clear downward trend, capture significant movements, and generate profit.