Correlation Risk
The hidden risk of holding several positions that tend to move together.
Also called: correlated positions · concentration risk
Written by Javier Sánchez Ros
In plain language
Two trades are only genuinely separate if they can lose independently. Three long tech stocks are, in practice, one large bet on tech.
Correlation also rises exactly when it hurts. Assets that behave independently in calm markets often move as one during a sell-off.
It shows up in less obvious places too: currency pairs sharing a base currency, commodity producers tied to the same underlying price, and crypto assets that follow bitcoin.
Worked through
Long four semiconductor names, 1% risk on each
- Tickers held
- 4
- Risk per name
- 1%
- Behaves like
- one 4% bet
- On a sector selloff
- all four stop out
Four different companies, four different balance sheets, four separate pieces of analysis. And one shared driver: demand for chips. On the day that story changes, the four charts stop being four charts.
Correlation is not a binary. Two unrelated stocks sit near zero, two names in the same sector might run at 0.7, and two share classes of the same company are effectively one position wearing two tickers. The higher the number, the more the separate risks collapse into a single one.
The cruel part is that correlation rises in exactly the conditions where diversification was supposed to help. On quiet days these four drift apart and the book looks nicely spread; in a panic almost everything moves together, and a portfolio built on normal-market correlations discovers it was one trade all along.
Practically: count exposures, not tickers. Four semiconductor positions are one semiconductor position, and it should be sized as one.
Why it matters
Correlation quietly multiplies your real risk per trade. Four correlated 1% positions can behave like a single 4% one.
Common mistakes
- Counting positions rather than independent risks.
- Assuming diversification across tickers means diversification across drivers.
- Relying on historical correlations that break down under stress.
Keep exploring
These concepts are connected. Understanding one usually makes the next one easier.
The combined risk of every open position, measured as a percentage of your account.
The set of rules that decides how much you can lose, before you think about what you can win.
The fixed share of your account you are willing to lose on any single trade.
The decline from an account’s peak value to its lowest point before a new peak.
An extended period of falling prices and generally negative sentiment.