The Virtual Portfolio | Learning How to Trade
What is a virtual portfolio? Every trader, novice or professional, understands that investing in the stock market carries risks. That is why training and practicing are among the basic pillars of trading, especially when we first approach the markets.
A virtual portfolio can help us on this path and in setting up an investment portfolio. In this article, I'm going to discuss how to create a virtual portfolio. However, first, let's discuss what an investment portfolio is and what it’s for.
Let’s begin!
Table of Contents
Investment Portfolio | Introduction
We can define an investment portfolio as a set of selected financial assets in which we deposit our capital to obtain potential returns. Ultimately, it’s about diversifying our investment to limit risk without reducing the potential return excessively.
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History note ✍️ The investment portfolio has its origin in 1952 in an article written by Harry Markowitz in which he developed his theory of portfolios, based on the optimization of the same. It’s a matter of selecting securities that, together, offer a high level of return for a given assumed risk. |
An investment portfolio must be analyzed as a whole, calculating the risk and return as a whole, although each asset must also be analyzed individually. To choose an efficient portfolio we must seek the maximum expected return in relation to the lowest possible risk. But what do we mean when we talk about risk?
Investment Portfolio | What is Risk?
When we talk about risk in investment terms, we refer to the probability of not achieving the desired return and even of registering unexpected losses. We must take into account the profitability/risk ratio when we make an investment portfolio since, if the risk is higher than the potential return, we may have a problem.
The less profitability, the less risk? This is generally the case, but with a diversified investment portfolio, we can reduce risk with little loss of performance.
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Investment Portfolio | Steps to Creation
How to create an investment portfolio? We must be clear about several factors that we explain below, along with the steps to follow to create a portfolio.
Objectives/Time Horizon
How to determine your investment objectives? The first thing we must do to set our goals is to thoroughly study our equity and capital situation and then set the goal. For this, it is important that we set a time horizon to achieve them.
➽ For example, a person nearing retirement is likely to seek higher returns in a short period of time. However, a person who has been in the labour market for a few years and wants to save for retirement can establish a time horizon of 20 to 25 years with moderate profitability.
Ultimately, it’s important to set up a list of goals and establish a defined time horizon to achieve them.
Risk Profile
The risk profile of an investor can be defined as the relationship between what they want to achieve, what they need to achieve it and the ability to achieve it. For example, I want to achieve a total return of 25,000 euros: how much capital do I need to invest monthly? Do I have the capacity to do it in five, 15 or 20 years? How much risk should I take based on the questions above?
From the answer to these questions, we will know if our profile is conservative, moderate or aggressive. Let's look at each of these profiles:
- Conservative profile. An investor with a low tolerance for risk, that is, cannot afford large losses of money. His goal is to obtain small returns on low-risk products, such as bonds.
- Moderate profile. This investor is willing to take a somewhat higher risk than the conservative, so he usually opts for a combination of fixed income and variable income assets, which raise the risk and the potential return a little.
- Aggressive profile. This investor is on the hunt for high returns with high risk tolerance. To do this, he usually opts for volatile financial assets and tries to diversify to reduce risk as much as possible.
Instruments/Sectors
Once we have established our objective and our risk profile, it is time to choose the financial instruments that we will include in our investment portfolio: stocks, bonds, Forex, commodities, etc. A conservative profile will look for assets with low volatility that are stable in the long term. For example, safe-haven assets including gold, the dollar or shares related to basic services such as electricity or gas.
Risk/Return Ratio
Once we have selected assets based on our risk profile, it’s time to build our investment portfolio. To do this, we must establish different combinations and calculate the risk/return ratio of each of these combinations. That is, optimize our portfolio.
Virtual Portfolio | What is it?
What is a virtual portfolio? It’s the portfolio on your demo trading account. A virtual trading account is almost the same as a real trading platform, but consists of virtual currency and a virtual portfolio of different instruments and virtual stocks. It’s called a virtual portfolio because you aren’t actually investing in real shares.
Virtual Portfolio | Why use it?
A virtual portfolio makes it easier for the trader to establish the four steps that we have indicated in the previous section more easily, since it allows simulations of investments without the need to risk real money.
Virtual portfolio shares can mirror real portfolio shares. This means that with a virtual stock exchange portfolio, you can trade in the same way with the same instruments and with the same charts and other information as you would with a real account.
The best virtual portfolio allows beginning traders to learn to speculate without risk. Trading in a virtual environment can be very useful for those who have little or no trading experience.
Let’s look at the advantages and disadvantages of a virtual portfolio, in detail.
Advantages
The main advantage of a virtual portfolio is that it serves as an educational tool to get started in the world of trading. If you don’t have the proper training, you could lose money if you jump directly into opening a real investment account.
Another advantage of a virtual portfolio is that it offers real market conditions, with real-time quotes, and is, therefore, very useful for making simulations as close to reality as possible.
It facilitates the acquisition of knowledge and habits, familiarizes ourselves with trading and market conditions, test strategies, techniques and tools.
Admiral Markets offers the possibility of creating a virtual portfolio through a free demo account. Here you can also practice your trading with virtual funds, under real and live market conditions, without putting any of your capital at risk. For more information, please click below:
Disadvantages
The main disadvantage of the virtual portfolio is that when you operate with it, your emotions aren’t the same as when you invest with real money. Controlling emotions is one of the keys to trading. They can tip the balance towards losses if they lead to impulsive and irrational decisions.
When you operate with a virtual wallet in a virtual portfolio, you risk more of your account balance because you know that you’re not going to lose real money. It’s advisable to use it to practice alone and move to a real account as soon as possible, and starting with small amounts of money.
Virtual Portfolio | Diversifying
Any investment portfolio, whether real or virtual, should be diversified. What does this mean? It shouldn’t be composed only of correlated assets.
For example, imagine that in 2008, we had a portfolio made up solely of US stocks. We would most likely have suffered large losses from the downturn in markets following the failure of Lehman Brothers in September of that year. However, if in that portfolio we had also included other assets such as gold or defensive stocks from other countries, we might have offset the losses or, at least, we would have minimized them.
A diversified virtual portfolio can be made up of:
- Stocks from different geographical areas. It is best to choose a combination of cyclical companies (related to economic growth) and defensive companies (they operate outside of economic cycles).
- Exchange Traded Funds (ETF). Funds that encompass a wide range of assets but are listed as a single listed share.
- Bonds. These fixed income assets guarantee long-term income. They are low risk and low return.
- Raw Materials. Like gold, oil or agricultural products.
Another way to diversify is to use Contracts for Difference (CFDs) so that we can hedge our positions and also trade on the value of shares without actually owning shares in a specific company.
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Other articles you may find interesting:
- The Benefits of Using a Forex Demo Account
- Ten Forex Trading Tips for Beginners
- Investing vs speculating - Are they the same?
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