Let's say you have a fondness for organic, fresh juices, and you decide to open your own juice bar in the center of town. You secure reliable vendors for high-quality ingredients, purchase an industrial juicer, and open for business. Your juice bar is attractively furnished, bright cheery, and you have a startup investment of $100,000. You finance the investment with an equity loan on your main residence. Your average cost to serve a glass of fresh juice, just based on overhead and labor expenses, is $1.00. At the price you feel is a fair value – $4.00, you're making $3.00 for each glass of juice you sell. You project an average of 100 customers per day, which is $300 per day or roughly $90,000 per year gross profit. That does not leave you with much to take as a salary once you pay off your overhead.
In this situation, you can only increase the profits of the existing business by increasing the number of customers coming through the door, by increasing the average amount spent by each customer, or both. So you try to increase the amount spent by each customer and add sandwiches to the menu.
Unfortunately, this doesn't really help your bottom line much, because while you may get a few more customers entering the shop ordering a sandwich, it doesn't really help the bottom line because of the additional overhead of purchasing the sandwich supplies and keeping them fresh. Most of your regular customers like the idea of fresh, organic juices and tend to shy away from sandwiches.
Now what?
You really want to be successful at this business venture. You've invested a lot of hard-earned capital. You decide to bring in a line of nutritional supplements not carried by anyone else in town, and advertise the addition. Now you begin to attract more health-conscious customers into the store for not just juice, but to purchase the supplements you offer. This increase traffic, and the increased profit realized from the supplements, adds to the bottom line.
What you have really done is made your business more diversified.
You have more than one profit center, and are attracting more customers into the shop. Your unique line of nutritional products puts you on the competitive edge if someone else in town were to open a juice bar.
How does all this relate to your trading business?
The same business principles that impact the feasibility of the juice bar being successful apply to trading. When you trade different time frames, markets, strategies and underlyings, you generate multiple potential profit sources. This helps to protect you when the market shifts and places any one particular strategy or underlying at a disadvantage. It also leverages your trading productivity, as you are now able to generate income from a variety of sources rather than just one, or even a few.
How can you diversify your trading business?
There are countless ways to diversify your trading business, depending on your style of trading. If you are a day trader, for example, you can diversify by trading both long and short positions, and allocating your trades to different stocks/indexes. You may also some positions overnight, creating diversification by time frame. If you are a longer term trader, you may trade different markets and underlyings with diversified entry and exit dates.
The key, for the trader as well as the juice bar, is to be sure that diversification adds diversity. Adding sandwiches to the shop menu did not achieve adequate diversification for the juice bar. Similarly, adding a Dow component to an SPX trade also fails to add unique value. Your diversification in trading should provide the opportunity for a totally independent and reliable income stream. When the juice business is slow, customers will still come in to purchase nutritional supplements because of their uniqueness. Similarly, when one of our trading strategies is in a draw-down period, other ones that are not correlated can sustain the desired income stream.
What are important considerations in diversifying your trading business?
When you diversify, you need to be certain you stay within your range of experience. It doesn't help your profitability as a trader to begin trading markets or strategies that have not been back-tested, and known to be successful. Remember, diversification only makes sense when it adds unique value to what you are already trading.
In summary, any successful business must always be innovative, and adding new sources of revenue to take advantage of changing markets is critical to long-term success. The same goes for a trading business to be successful over the long-term. Markets change, trends change, and the level of volatility and risk in trading change. However you may choose to diversify your trading business, do your homework so that you are comfortable that your trade plan has enough potential income sources to weather any storms that may pop up on the horizon.
Feel free to comment below if you would like to share ways you have diversified your trading business.
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