This article originally appeared on The DIV-Net on June 25, 2009
There is a general perception that higher number of stocks in a portfolio provides better diversification (i.e. better risk management). I am discussing the relationship between number of stocks and its effect on diversification. I am using very simple probability mathematics for an ideal scenario.
I am using a stock being positive or negative as measure of diversification. In an ideal scenario, at a minimum, one would like to have all stocks to be positive relative to the buy price. For example, if a portfolio has 5 stocks, then one would like to have all positive side. If a portfolio has 10 stocks, one would like to have all in positive side and so on. Please note that I am not discussing the value of individual stock or portfolio. It is likely that a positive value in one stock can offset the negative value of other stock. continue reading rest of the article….