Risk

Correlation

In one sentence

The tendency of two instruments to move together - the reason several open positions can secretly be one bet at several times the intended size.

Long EUR/USD, GBP/USD and AUD/USD is a single short-dollar position. Long five large altcoins is a single bet on crypto beta. In both cases the risk is the sum, not the individual tickets.

Correlations are also unstable: assets that behave independently in calm markets frequently converge to 1 in a crisis, which is precisely when the diversification was supposed to help.

The mistake it causes: believing risk is diversified because the ticker symbols are different.

When ten positions are one position

Risking 1% on each of ten trades is not 1% risk if they are the same bet wearing different tickers.

What it looks likeWhat it actually is
Long EUR/USD, GBP/USD, AUD/USDOne short-dollar bet at 3x size
Long SOL, AVAX, NEAROne crypto beta bet at 3x size
Long gold and short USD/CHFLargely the same risk-off bet
Long BTC and long a BTC miner stockOne bet with extra equity risk

The test is one question: what single thing has to be true for all my open positions to work? If the answer is the same for every ticket, your real risk is the sum, not each one separately.

Correlations break exactly when you need them

Assets that behave independently in calm markets frequently converge toward 1 in a crisis, because in a liquidation everything is sold to raise cash. That is precisely the moment diversification was supposed to help. Any risk model built on historical correlation is quietly assuming the future stays calm.

Crypto is one asset wearing three thousand names

Most altcoins are high-beta expressions of the same directional bet, amplified. Holding ten of them is not a diversified portfolio, it is a leveraged position on bitcoin with worse liquidity. See altcoin.

What to do with this

  • Cap total risk across correlated positions, not just per trade. If three trades are one bet, size them as one.
  • Before adding a position, name what it is a bet on. If you cannot, you do not know what you own.
  • Assume correlations go to 1 in the worst week of the year, because historically they do.

Related terms

Position sizing Choosing how large a trade to take so that hitting your stop loss costs a fixed, small, pre-decided percentage of the account. Altcoin Any cryptocurrency other than bitcoin - a category that covers everything from large, liquid networks to tokens with no users and no float. Currency pair Two currencies quoted as a ratio - the base currency first, the quote currency second. The price is how much of the quote currency one unit of the base is worth.

This term is explained in context in the primer - and priced exactly in our free risk calculators .

More in Risk: Stop loss, Take profit, Risk-to-reward ratio, R multiple.

Education only, not financial advice. Trading is high risk and most retail accounts lose money.