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How to choose the right product

Lesson 7 of 7

Using a multi-product strategy

One of the beauties of the stock market is that you can engage with it however you choose. As we mentioned previously, you may prefer to use different products simultaneously to help you meet your financial goals.

In this lesson, we'll outline some of the common multi-product strategies used by traders and investors. You can select elements from one or more of the methods we’ve included or create one that’s tailored to your needs.

However, before we jump into some examples, let's look at why you might want to use a multi-product strategy.

Benefits of a multi-product strategy

Putting all your investments into one stock or account can be risky. The same is true for trading on only one market. The value might increase, meaning you turn a profit. But if your position doesn't perform well, you may end up with a loss.

Firstly, a multi-product strategy can help you better achieve your aims. Remember, you’ll likely have several different goals like saving for retirement or getting together the capital needed for a deposit on your new home.

A diverse, multi-product strategy could help you support these and provide you with the money that you need when you need it.

With this wide-ranging approach, you could also use hedging to help protect your portfolio from significant losses.

Did you know?

Hedging is a strategy used by both traders and investors in slightly different ways. It attempts to limit the risk in your portfolio and minimise the impact of your losses.

Say you’ve invested in tech stocks, hoping for long-term growth and profits. However, you see a recent news announcement that may negatively affect the market prices.

You could use derivatives to open a short position that would profit from a fall. If the market price does indeed decrease, the derivatives would increase in value.

Common multi-product strategy structures

When you’re building your portfolio, you can follow the structure of a pyramid. At the bottom, you may choose to include various investment products as they’re typically lower risk.

As your structure narrows towards the middle, you could purchase individual shares, slowly increasing your liability.

Then, right at the top of your pyramid, you might include leveraged trading. This is generally considered the highest risk.

If your leveraged positions experience a downturn, you could only be losing the smallest piece of your overall portfolio, while the rest might be safe and can continue growing over time.

The key to a successful pyramid is to build on a solid financial foundation and limit exposure to more risky investments at the top.

Adopting this approach can give you power over exactly how much risk you’re willing to take on, and how much time you want to spend managing your portfolio.

In the sections below, we’re going to illustrate different versions of the pyramid you might adopt, starting from the bottom.

Pyramid 1: combining different investment products

This low-risk structure for a portfolio would be classified as a long-term strategy. You might invest your capital in bonds or a savings account, or choose ETFs and managed portfolios comprised of stocks and perhaps some bonds for stability.

A diagram of a pyramid depicting an investments-only portfolio.

The shape here may resemble a rectangle more than a pyramid, but it’s still a multi-stock and multi-asset strategy.

Having numerous stocks mixed with some bonds reduces investment risk and creates a strategy that’s relatively simple to manage.

While it can take more time, this approach has the potential to produce returns ahead of inflation and create real wealth.

Pyramid 2: adding individual shares to your strategy

In this instance, the pyramid might have a base of collective investments, with individual shares making up the top part.

You can use multiple investment products with different levels of risk. However, you’re still able to avoid the increased volatility of leveraged trading.

A diagram of a pyramid depicting a portfolio that combines investment products and stocks.

Did you know?

Among the different categories in which we could classify the shares of listed companies there are two that many investors consider when designing their investment portfolios: growth stocks and value stocks. Your investment style and goals may dictate which will suit you best.

Growth stocks belong to companies that investors believe will deliver above-average returns. These tend to be volatile, so you’re more likely to earn a profit from the quick price changes than from dividends.

However, this could make investing in growth stocks riskier. If your expectations for fast growth are misplaced, you may make a loss.

On the other hand, value stocks refer to those from companies that are currently considered ‘undervalued’ by other investors. Here, you’re hoping to purchase stocks that have a demonstrated history of good profit.

Typically, these remain steadier, with the market price rising slowly and a greater likelihood of receiving dividends. As with any investment, there’s no promise of future profits.

Value stocks could be correctly priced by the market and so purchasing them might not be the bargain you’d assumed.

Within the individual stocks part of the strategy, you can allocate funds to some dividend-paying value stocks in the middle and to growth stocks right at the top. While they can add to returns, they may also add to your overall risk.

You could split your investments in several ways to form the pyramid. But remember, the bottom section should ideally have a larger percentage. The passive, diversified base could form 60% and the rest can be split between individual stocks.

Pyramid 3: combining investment and trading products

Adding on from the previous option, you may want to include a trading portfolio right at the top of your pyramid. While this will add more risk, it’s less likely to destabilise the structure because of its sturdy base. It also has the potential to add to your overall returns.

A diagram of a pyramid depicting a portfolio that combines investment and trading products.

The trading products used can also further diversify your portfolio. Plus, they could be used to add some security if you choose a hedging approach.

Another way to ensure your portfolio can weather volatile markets is by using a derivative product to take a short position, like CFDs, ETPs or options. Let’s see how using a put option would work.

If you anticipate that the market will fall, these will rise in value as the underlying asset depreciates, providing you with a potential profit to offset your losses.

If your positions have a strike price that’s lower than the current market price of the underlying, they’re known as ‘out-the-money’. The strike price is the level at which you can exercise the option. In the case of a put option, this means selling at that price.

When a put option is ‘out-the-money’ it’s likely to be cheaper because it doesn’t have any intrinsic value yet.

You could also choose put options that are long-dated, meaning you can hold them for longer.

Let’s look at how it works.

Question

Say the US Tech 100 is trading at 9500. For a put option to be out-the-money, you want the strike price to be lower than the index’s current level.

You’re using this option as a method of insurance in case the market moves against you, so you want to exit the position when it’s 10 -15% lower than its current level.

Which of the following put options would you buy?

  • a 8467
  • b 9467
  • c 8597
  • d 9097

Correct

Incorrect

Ten percent of 9500, the current market price, is 950. If you subtract 950 from the current market price, it will equal to 8550. Of the possible solutions supplied, only A) 8467 is more than 10% lower than the current market level. To confirm this, you can use the following calculation: 9500 - 8467 = 1033. If you then divide that by the current market price and multiply the value by 100, you’ll see that option A is 10,87% lower.
Reveal answer

Using options can be a complex strategy, but it might be worth considering as they can help you mitigate some of the risk. They can offer short-term protection if you’re risk-averse and worried about a market selloff.

In this strategy, you may keep the base made up of passive products, and managed portfolios could remain higher than 50%. You can allocate 30-40% to shares (split to favour more of the value stocks), while your trading activity at the top would sit at 15% or less.

Pyramid 4: a trading-only strategy

Entering the markets using trading alone could be a risky option because the base of your pyramid might lack the stability you could get from long-term investments. However, you can still structure your pyramid to manage your overall risk.

A diagram of a pyramid depicting a trading-only portfolio that combines different products.

Your base could include exchange-traded products (ETPs) that can diversify your portfolio, but with a lower level of leverage.

Options, with their limited downside, might also work for you at the lower end of the risk pyramid. While they do use leverage, it’s often lower, and the downside is capped at your initial outlay. Just note that when you sell a put option, your losses are potentially limitless.

With this strategy, your base of leveraged ETPs would cover between 50% and 75%. Right at the top, you could allocate 10% of your funds to fully leveraged individual assets. The remainder might include options, which limit your downside risk.

Pyramid 5: using an options trading strategy

Another way to structure the trading part of your portfolio is by using options.

Remember that call options increase in value when the underlying asset is rising, while put options increase as the underlying’s value falls.

A blend of call and put options on different assets could reduce overall risk in your pyramid because you’d profit from both rising and falling markets.

A diagram of a pyramid depicting a portfolio that uses options and other derivatives.

In this instance, you’re hoping that the profit from one might offset the losses from the other. Choosing uncorrelated assets can help you optimise this strategy.

If you’re using options as the trading part of a diversified pyramid portfolio, they can offer insurance as detailed earlier in this lesson.

Question

Say you have a lot of oil stocks in your portfolio. Buying put options on Brent crude, for example, could help you balance out your risk. What would this strategy be called?
  • a Diversification
  • b Hedging
  • c Scalping

Correct

Incorrect

The above strategy is known as hedging. If oil falls, so will your oil-related shares, but the put option would increase in value. Scalping refers to when you try to profit over small price changes in the market. Diversification, on the other hand, includes introducing various other stocks and markets into your portfolio.
Reveal answer

The methods we’ve outlined in this lesson aren’t the only options available to you. The general idea is to structure your pyramid according to your own needs and risk profile.

You can choose whichever low-, medium- or high-risk solutions fit within your financial goals.

Lesson summary

  • There are several ways to implement a multi-product strategy to achieve your financial goals
  • The products you choose to include may depend on your risk profile, time horizons and personal understanding of how they work
  • You could choose to stick to investing, trading or a combination of the two
  • Visualising your portfolio structure as a pyramid might help you build a stable base so that your entire strategy is less affected by major shifts in the market
  • Using options or ETPs means you can hedge other parts of your portfolio and offset potential losses
  • However, remember that with IG International you can only trade via CFDs
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