Background
The maxim " Do not put all your eggs in the same basket ".
It means you should not put your all your wealth in One asset only, rather you should invest in many asset. In other words, the maxim suggest diversification of investment for Risk reduction.
Portfolio is a combination of securities ( Cryptocurrency, Foreign currency, Shares of a company etc. ). Combining securities in a portfolio can reduce the Risk because some of the fluctuations offset each other. Investor can reduce Risk ny holding investment's in diversified portfolio.
Modern Portfolio Theory ( Markowitz )
Modern Portfolio Theory seeks to construct an optimal portfolio by considering the relationship between Risk and Return. The theory recommends that the Risk of a particular security should not be looked on standalone basis, rather it should be looked in relation to portfolio. A security may be very riskey but when combined with other security, the combination may not be that much riskey because some of its -ve fluctuations may be set off by +ve fluctuations of other security.
Markowitz showed that, by using portfolio, the Risk can be minimised without reducing the expected return, by diversifying out the unsystematic risk.
Example
Suppose there are two Cryptocurrency. X ( Expected return-10% and SD-15% ) and Y ( Expected return -20% and SD-30%) and covariance between X and Y is Zero ( Zero covariance means there is no relation of price movement between X ad Y )
We can see that Cryptocurrency Y is more riskey (higher SD ), so anyone can say don't invest in Y, but by diversification we can reduce Risk.
Let, I have 100$ to invest. I invested in lesser riskey Cryptocurrency i.e X, it means I will get 10% return and for that I am bearing a Risk of 15%.
and you are a smart investor, you invested 80$ in X and 20$ in Y, then your Return and Risk will be.
Return
=( Return on X + Return on Y )
= ( 80*0.1) + ( 20*0.2 )
= 12 or 12%
Risk
= √[ {w1^2}*{SD1^2} + {w2^2}*{SD2^2} + 2{w1}*{w2}*r*{SD1}*{SD2}]
=√[{0.8^2}*{0.15^2} + {0.2^2}*{0.3^2} + 2*{0.8}*{0.2}*{0}*{0.2}*{0.3}]
= 0.1340 or 13.40%
Above calculation shows, you in better condition than me in both terms.
My Return and Risk (10% and 15% )
Your Return and Risk ( 12% and 13.40%)
Thank you for reading.
Good