Asset selection: What assets to choose
The chaos of the last seven months has upended trading strategies as a sustained bull run came to a jarring halt. Now, traders are forced to contend with a new era of soaring inflation and a rethink of their approach.
There are a number of approaches they can choose from to craft this strategy, from various asset classes to different financial instruments, such as derivatives.
What are trading assets?
Traders should take a lot into consideration when shaping their strategy. They can begin by looking at an asset class, which could arguably be the key decision they make as traders.
So, what is an asset class?
An asset class definition refers to investments that share similar characteristics, like the tangibility of commodities, or the fact that stocks are the publicly traded assets of companies.
Assets to trade include stocks and stock indices, bonds, foreign exchange and commodities. While all broadly adhere to the classic principles of supply and demand, they operate in their own financial ecosystems and respond to different internal and external ramifications.
Traders may choose to stay within a single asset class, or mix them up for hedging or diversification. Various asset classes may behave differently during all stages of an economic cycle. Therefore, it’s important to understand the mechanisms behind them, and to adjust your trading strategy accordingly.
Note that asset classes and financial instruments are different subgroups. The latter includes derivatives such as futures and options contracts contracts for difference (CFDs). Traders may choose to use derivatives for any asset class.
Trading stocks and stock indices
A stock, equity or share is a stake in a company that is publicly traded on the stock exchange, and is a cornerstone of most asset selection strategies. The value of a company is determined by the number of outstanding shares multiplied by the value of each share. The final number is its market capitalisation.
Companies typically go public after a sustained period of growth from venture capital, with their entrances, through either an initial public offering (IPO) or an increasingly popular special purpose acquisition company (SPAC), often met with huge fanfare.
Trading assets has become synonymous with stocks, which allows traders to speculate on the share prices of the world’s biggest companies, like Apple (AAPL), Microsoft (MSFT), Tesla (TSLA) and Google owner Alphabet (GOOGL).
Stocks also offer a quantitative assessment of good and bad news, including massive sell-offs for Netflix (NFLX) and Facebook-owner Meta Platforms (META) this year following disappointing earnings results.
Stocks trade on exchanges, like the New York Sock Exchange (NYSE) and the NASDAQ in the US, the London Stock Exchange (LSE) in the UK and the Euronext in Europe.
Traders can speculate on stock prices by buying stocks directly on the exchanges, or by trading derivatives such as futures and options contracts, contracts for difference (CFDs).
Some derivatives, such as CFDs, allow traders to speculate on the price both rising and falling through long and short selling. Note that CFDs involve trading on margin and using leverage, which means both profits and losses can be magnified.
Stock indices
Derivatives also allow traders to speculate on collection of stocks through index trading. Indices refer to baskets of stocks, with their price calculated from the prices of its components, typically as a weighted average.
Indices typically aim to reflect the state of a broad industry sector, or a country’s stock market as a whole. For example, S&P 500 (US500) and FTSE 100 (UK100) are the respective US and UK large-cap benchmark indices.
Traders can also speculate on index-tracking exchange-traded funds (ETFs), also known as index funds.
Tangible valuations
Stocks have long been the most talked about asset, because once a company floats publicly it effectively becomes a living, breathing organisation, with investors able to assess the impacts of internal and macroeconomic factors on a company’s value.
They also span every industry, allowing traders to respond to things like commodity shocks and sectoral news that may not spread across the whole economy.
Public companies are required to display detailed quarterly and annual financial statements to investors, allowing a fair assessment of the stock’s value. Traders can therefore use fundamental analysis to determine their stock trading strategy.
Earnings seasons may offer rewards
The tangible nature of stocks means that sudden movements could potentially help the strategic trader to turn a quick profit, especially during earnings seasons. Yet, of course, all trading contains risk of losses, and earnings season is no exception.
Most big companies report financial results on a quarterly basis, four times a year. They also typically do it as a sector, with tech companies often reporting in the same week as each other, much like bank stocks.
They also receive a lot of analysis in the build-up, with consensus earnings per share (EPS) forecasts helping gauge stock news.
Volatility
Stock market volatility means stocks can rise or fall by double-digits in a matter of hours based on unexpected company announcements, earnings releases and other news.
The plight of Twitter’s (TWTR) stock, which jumped from $33 to $51.70 as Elon Musk announced a takeover, then retreated to $33 when he pulled out, could illustrate the kind of price fluctuations that stocks may ride through.
But with high volatility also comes higher risk of loss, therefore risk-management plan is important. To protect themselves, traders could consider setting up stop-loss orders, meaning that if the share price moves against their expectations, the position would close at a predetermined figure.
Trading FX
Asset selection, though, need not only involve those dealt within regimented trading hours like stocks, with round-the-clock assets like foreign exchange (FX) also popular among traders.
FX trading is the process of trading two duelling currencies in the hope of turning a profit. Yet of course, risk of losses is always there in trading. They are normally traded with one anchor currency, with the most popular being the US dollar, the euro, the Japanese yen, and the British pound, according to Statista’s data between 2001 and 2019.
Currency trading occurs in pairs, weighing the value of one currency against the other, and is typically done via derivatives. As of 8 August 2022, EUR/USD, USD/JPY and GBP/USD are the most traded pairs on Capital.com's CFD platform.
FX markets typically respond to economic news such as data releases, central banks meetings, and wider geopolitical news.
FX is seen as an appealing asset class for retail traders because of its low barriers to entry. FX pairs operate 24/7, and they are typically traded via derivatives, such as futures and options contracts, spread bets and contracts for difference (CFDs).
Some derivatives, such as CFDs, allow traders to open both long and short positions while trading on margin, meaning leverage is involved. Leverage allows you to open bigger positions with less amount of funds, borrowing the rest of the sum from your broker.
While leverage can magnify your profits, it can also magnify your losses, and therefore should be used with caution. Always conduct your own research before trading, and never trade money you cannot afford to lose.
There’s always a winner
Because FX involves a pair of currencies being traded against each other, savvy traders can potentially gain even during bearish economic landscape. Although, of course, all trading involves risk of losses and you should always conduct your own due diligence before opening a position.
The dollar, for instance, could be regarded as a safe haven asset, because investors flock to it in times of economic uncertainty as a way to protect the underlying value of their holdings.
Likewise, central banks exhibit varying responses to global economic downturns, helping strengthen a currency relatively even as its economy declines.
Trading commodities
Commodities’ value is heavily linked to supply and demand. They can be traded on their own exchanges, like the London Metals Exchange (LME) or the Chicago Mercantile Exchange (CME), through exchange-traded funds (ETFs), or through futures, options contracts, and other derivatives such as CFDs. Note that some derivatives may involve leverage, which can magnify both profits and losses.
Commodities are responsive to supply and demand shocks, with the former often regulated by a body, like OPEC’s control over a significant share of oil production in the global economy.
Asset selection here normally falls into specialisms within energy and metals commodities, for example.
Hedge against inflation
A 2021 research paper, The Best Strategies for Inflationary Times, looked at historical returns of different asset classes and equity sectors when the US headline inflation figure moved above 5% over the past 95 years.
Its findings revealed that all commodities showed positive returns under inflationary pressure, averaging an annualised 14%. This contrasts with normal periods when commodity returns are in single digits.
This may be because commodities tend to be the underlying cause of rising prices. In 2022, with tight supply chains following the relaxation of Covid-19 restrictions and Russia’s invasion of Ukraine, commodities are the major driver of soaring inflation.
Oil prices spiked from around $80 at the start of 2022 to $125 by 8 March following the invasion of Ukraine, as supplies had already begun to tighten.
Other commodities, like potassium chloride, coal, wheat and nickel, saw jumps in excess of 50% in the first five months of 2022, even as the stock market tumbled and the oil-tied Russia ruble bottomed out.
During inflationary periods, traders can choose to invest in the source input. That also means that commodities may offer a decent hedge within a portfolio that also includes stocks.
Driven by supply and demand
As commodity prices are mostly shaped by supply and demand dynamics, their prices may be challenging to predict, which can cause heightened volatility.
Various external factors such as weather, political unrest, labour strikes and more can drive the price of the commodity. These events can happen erratically, leaving the price more volatile. Unlike stocks, there are almost no fundamental financial metrics that influence the price of commodities.
Sensitive to economic ramifications
Commodities have recently become a popular countering force to the inflationary spiral gripping the West. But wider geopolitical and economic trends are more frequently a source of dread.
Recessionary headwinds typically hit demand for everything, meaning that oil, coal and metal could decline in price.
Commodities are currently also sensitive to a “bullwhip effect”, following over-ordering of materials as the economy restarted following the Covid-19 pandemic.
Asset selection: Final thoughts
Trading different asset classes may offer advantages, but each can have its drawbacks. You should choose asset classes based on your trading strategy, risk appetite, trading goals and timeframes.
Make sure to conduct your own due diligence before trading, looking into technical and fundamental analysis, latest news and analyst commentary. Note that past performance does not guarantee future returns, and never trade money you cannot afford to lose.
FAQs
How many asset classes are there?
There are several asset classes, including stocks and stock indices, bonds, commodities and foreign exchange. You can also trade different asset classes via derivatives such as futures and options contracts, spread bets and contracts for difference (CFDs).
Which asset class is most profitable?
All asset classes have their own routes to profitability, and all contain risk of losses. You should choose asset classes based on your trading strategy, risk appetite, trading goals and timeframes.
What is the most stable asset?
All assets carry risk. Index trading offers diversification, while traders can also put their eggs in different baskets through a collection of FX pairs, commodities and stocks.
Markets in this article
