Different asset classes respond in different ways to various fundamental developments. For example, you can have short-term government bonds selling off because the central bank is tightening monetary policy or an FX pair in an uptrend because the central bank of the currency that is appreciating is raising interest rates while the central bank of the currency that is depreciating is cutting rates. You can also have different equity sectors performing differently depending on the economic cycle.
When you build your trading theses you should find a market where your idea can be expressed in the best possible way giving you good asymmetric bets. This process will also keep you disciplined as you will only look for the highest conviction trades and refrain from taking positions just out of boredom. Remember your job is not to trade but to make money.
For example, let’s say that you have two central banks beginning to tighten their monetary policy. You may have the relative FX pair just ranging and not giving you any clear trade. What you can do though is trading the short-term government bonds as an increase in interest rates will cause a sell-off in those securities. In this way you reduce your risk and increase your overall chances of success.
With more experience you’ll start to notice that when you have a high conviction in your trade because you clearly see the reasons for taking a position, your psychological pressure will be much lower compared to the times when you force trades trying to outsmart the market. As the saying goes “when in doubt, stay out”.
As you can see, risk management can also come in the form of asset class selection. Even if you only trade the FX market, you can still apply this concept by trading only the pairs where you have lots of odds stacked in your favour by reducing the margin of error.
