Now, let's come back to the idea of lowering the waves.
People say that there is no such thing as a free lunch.
But in investing, people often say there is one.
Diversification.
Usually, diversification means spreading your investments across assets or stocks that have relatively low correlation. Sometimes, spreading your investments across time, as with DCA, can be considered a form of diversification.
But the underlying idea is the same.
Combine multiple things that fluctuate, and average them out to reduce the fluctuations, i.e., lowering the waves.
You could think of it as a slightly generalized version of the law of large numbers we discussed in the previous post.
But is it really free?
Imagine diversifying across stocks from a country or an industry that is in decline.
No matter how much you diversify, they can eventually all go down together.
Why?
Because diversification can lower the waves, but it cannot guarantee the direction.
Diversification becomes a free lunch only under the assumption that the assets or market you have chosen will grow overall over time.
In other words, to make diversification a true free lunch, you need a long-term view of what you are choosing.
Sector ETFs or products such as the Nasdaq 100 are among the financial instruments that allow you to take advantage of this diversification effect to a large extent.
Then, what is the free lunch in trading?
In investing, diversification is primarily achieved across different assets.
But for an individual trader, trying to achieve meaningful diversification across a large number of instruments is usually asking too much.
It makes more sense to look for diversification along the time axis.
(As mentioned above, DCA in investing is also a way of diversifying across time.
If you DCA into an ETF or the Nasdaq 100, you can effectively diversify across two dimensions: assets and time.)
In trading, then, repeating the same method again and again is how you lower the waves over time.
Then what corresponds to the "long-term view" that sets the direction, the one we talked about in investing?
It is the edge of the trading method.
So, ultimately, the free lunch in trading is this:
Repeatedly executing a trading method that has an edge.
In fact, I would go even further.
I would argue that this is almost the only structure through which long-term success in trading can be achieved.
Why?
And why is this not merely a philosophy, but a probabilistic structure that can actually produce success?
We'll continue in the next post.
This post is educational content about trading. It is not investment advice or a recommendation to trade any specific instrument.