Trading Portfolio Management and Investment Allocation in Financial Markets

Introduction to Trading Portfolios and Portfolio Management in Financial Markets
 

Success in financial markets is the result of careful planning, proper risk management, and a thorough understanding of the core concepts in this field. Among these key concepts are the portfolio—an investment basket—and portfolio management. In this article, we aim to examine in detail what a trading portfolio is, explore its types, and learn how to implement portfolio management strategies in various markets such as the stock market and cryptocurrencies.

What Does "Portfolio" Mean? (Definition, Pronunciation, and Simple Concept)

The term "portfolio," often referred to as an "investment basket" or "stock basket," essentially refers to a collection of financial assets that a trader has grouped together with the goal of generating profit. Regarding the meaning and pronunciation, the term originates from French ("Portefeuille") and is pronounced as "port-fo-lio" in financial market contexts. It is worth noting that the terms "portfolio" and "trading basket" convey the same meaning.

To better understand the concept of a portfolio, it is important to note that when we invest all our capital in a single stock or asset, we drastically increase our risk of loss, as the decline or collapse of that asset puts our entire capital in jeopardy. In a trading portfolio, however, we hold a combination of different assets, including shares of various companies, gold, cryptocurrencies, currency pairs, and even cash. Thus, if a portion of our assets experiences a price decline, another portion that has achieved gains can offset the resulting losses, keeping overall returns at an acceptable level.

 

Types of Investment Portfolios

Depending on our financial goals and risk management needs, we can form various types of investment portfolios. These portfolios can be categorized based on the type of asset held or their underlying strategy, which we will outline below:

 

Stock Market Portfolio

This type of portfolio consists of a collection of shares of public companies listed on the Iranian Stock Exchange. The main objective of entering a stock portfolio is to select shares from different industries, such as petrochemicals, oil, banking, automotive, etc., to reduce risks caused by the fluctuations of any single industry and, from a broader perspective, achieve profitability. For example, we might include the banking stock "Webmellat," the automotive stock "Khodro," and the petrochemical stock "Shabandar" in our stock portfolio.

 

Cryptocurrency Portfolio

If we are looking at a crypto portfolio or a dollar-denominated portfolio, this section is of special importance. Due to extreme volatility, high liquidity, and the dependence of some currencies on news, a comprehensive crypto investment basket is required in the digital currency market. Generally, the best cryptocurrency portfolio usually includes a combination of the following:

• Leader currencies for maintaining portfolio stability (such as Bitcoin and Ethereum)
• Stablecoins to preserve dollar-denominated value (such as Tether and USD Coin)
• Altcoins for higher growth potential (such as Ripple and Cardano)

 

Gold and Fixed-Income Portfolio

A gold portfolio can be a combination used to reduce risk and preserve the value of our assets. In this context, the presence of gold in the portfolio helps us protect a portion of our capital against inflationary fluctuations. Furthermore, gold funds are a suitable choice for those who want to profit from gold market fluctuations without purchasing physical gold. On the other hand, combining gold with fixed-income assets creates a unique balance between return and security; for example, including fixed-income funds alongside gold can form the secure, risk-free portion of our basket, providing a steady cash flow for the portfolio during market downturns.

 

How to Build an Investment Portfolio?

Building a proper investment portfolio is one of our most important actions for managing asset risk and achieving sustainable and appropriate returns. By choosing the right assets and managing the portfolio, we can invest correctly and protect our trading portfolio from market volatility. Below, we address the steps to optimize an investment portfolio:

 

Determining Financial Goals and Risk Tolerance

Before taking any action, you must determine what the goal of your investment is. Are you looking for long-term capital growth, or is your goal to earn a fixed monthly income? Furthermore, our risk tolerance depends on factors such as age, financial obligations, personality type, capital amount, etc. The type of investment portfolio (aggressive, defensive, etc.) is determined by these very variables. For example, an 18-year-old entering the world of financial markets usually has a higher risk tolerance than someone nearing retirement and can therefore maintain an aggressive portfolio.

 

Selecting and Combining Assets

After defining the strategy, it is time to select the appropriate assets for the portfolio. We should choose assets that have an inverse correlation with one another. In other words, when one asset decreases in price or value, the other remains stable or grows. For example, an investment basket that combines stock market equities and gold is considered a suitable combination of assets.

 

Diversifying the Investment Portfolio

Portfolio diversification is one of the most important topics in portfolio management. We should not focus on just one asset, a specific financial sector, or a particular industry. Distributing capital across different asset classes (stocks, cryptocurrencies, gold, etc.) and across various industries within the Tehran Stock Exchange ensures that the portfolio risk is reduced to an acceptable level, although other factors also influence profitability.

 

How to Manage a Trading Portfolio
 

Trading portfolio management plays an important role in controlling risk and optimizing returns. Portfolio management is not a one-time act; rather, it is a continuous process. By monitoring market conditions, managing trade positions, diversifying assets, and making principled decisions, we can improve our investment performance. Below, we discuss portfolio management and how to handle it:

 

Setting Stop-Loss and Take-Profit Levels

Discipline is the first step in managing a trading portfolio. Setting stop-loss and take-profit levels is essential for trading. These tools help us distance ourselves from emotional decisions and implement our trading positions based on analysis and logic.

 

Calculating Portfolio Risk and Return

Calculating the risk and return of a portfolio is one of the pillars of our capital management, as it shows us how vulnerable an investment basket can be to market fluctuations and, conversely, how much profit it brings us.

To calculate the return of a portfolio, we multiply the return of each asset by its weight in the portfolio and take the sum. For example, if 60% of the portfolio is in one asset with a 10% return and 40% is in another with a 5% return, the average portfolio return is about 8%. For risk, we generally measure the volatility of returns; for instance, if the price of an asset constantly fluctuates between 900 and 1200 Tomans over time, its risk is higher than that of an asset that only changes between 980 and 1020 Tomans. Therefore, in portfolio construction, one must always consider both return and volatility.

 

Constant Optimization and Review of the Basket

Market conditions are never constant over time. Assets that were market leaders last year may face stagnation this year. Therefore, it is necessary to review our investment basket at different intervals, such as every 6 months or once a year, and rebalance if necessary according to our desired strategy—meaning we adjust the ratios between assets to maintain balance. This process can be carried out by selling a portion of assets and purchasing other valuable ones.

 

What is Portfolio Risk and How is it Reduced?

Portfolio risk refers to the likelihood of a decrease in portfolio value due to factors such as market volatility and poor, sometimes unforeseen, asset performance. As previously mentioned, the more capital is concentrated on a limited number of assets, the higher the portfolio risk usually becomes. For this reason, it is advisable to strive to manage and control our basket's risk using various methods. In this section, we will address the concept of portfolio risk and the most important strategies to reduce it, including diversification and asset allocation management.

 

Types of Risk in an Investment Portfolio

In portfolio management, identifying types of risk is of great importance. Each risk can affect our portfolio's performance differently. In general, investment risks are divided into two main categories: systematic risks and unsystematic risks. Understanding them helps us make better decisions for managing our portfolio and reducing potential losses.

1. Unsystematic Risk: A type of risk in financial markets caused by the internal operations of a specific company or industry; such as operational risks like a fire in a company's production line, business risks like mass layoffs, or financial risks like the loss of half of a company's capital.

2. Systematic Risk (Market Risk): A risk that affects the entire market, not just a specific stock or asset, which is typically referred to as market risk. The outbreak of war or changes in interest rates can be considered examples of systematic market risks.

 

The Role of Diversification in Reducing Risk

By diversifying assets and distributing capital among them, we can reduce the probability of loss. In a diversified portfolio, the weak performance of one asset does not necessarily mean a decline for the entire basket, because other assets may perform better and offset part of the loss.

For example, if we concentrate all our capital on the shares of one company, or one cryptocurrency, or one currency pair, we may suffer significant losses with a price drop. However, if we divide our capital among stocks, cryptocurrencies, currency pairs, fixed-income funds, gold, etc., the negative impact of an asset's decline on the overall portfolio will be reduced. Although diversification cannot eliminate systematic risk, it can significantly mitigate the intensity of market shocks and provide peace of mind to the investor.

 

What is a Real-time Portfolio?

A real-time portfolio is a live and online display of our asset basket, the value of which changes in real-time based on the latest live market prices. The difference between a real-time portfolio and a standard portfolio lies in the factor of time and update speed; in a normal portfolio, the value of assets and our profit/loss are usually calculated at the end of the trading day. However, a real-time portfolio allows us to view our trades, asset basket value, and current profit or loss at any moment, enabling us to make better trading decisions.

 

What is the Best Investment Portfolio?

The answer to this question differs for each person, but successful patterns can be introduced:

Sample Long-Term Stock Market Portfolio

For a long-term outlook (more than 3 years), the best investment basket in the stock market includes the following:

• 35% Fundamental and Profitable Company Stocks: Focusing on large, export-oriented, and dollar-based companies that have high dividend payouts (D/P) and solid cash flow to maintain basket stability on negative market days.

• 30% Gold Funds or Commodity Deposit Certificates: (Increasing the share as the main defensive weight) In this portfolio, gold acts as a driving engine in sync with the free-market dollar and global ounces, insulating the entire capital against hyperinflationary cycles and the devaluation of the national currency.
• 25% Growth and Small-Cap Company Stocks: Smart selection of companies with low market capitalization or those with major development plans that have the potential for price jumps distinct from the overall market.
• 10% Fixed-Income Funds: Holding a small portion of capital as cash in fixed-income funds, solely for the purpose of parking money and having immediate purchasing power (ready liquidity) to hunt for stocks at price bottoms.

 

Sample Cryptocurrency Portfolio

A balanced sample of a cryptocurrency investment basket for a moderate-risk investor could be as follows:

• 50% Bitcoin (King of the market and store of value)
• 25% Ethereum (Largest smart contract blockchain)
• 15% Stablecoins (Tether or USDC) to hunt opportunities during market corrections
• 10% Promising Altcoins in DeFi or Metaverse fields