Correlations
Two similar trades are one trade at double the size. Risk adds up, it does not divide.
Correlations — what it is?
Correlation is the degree to which two instruments move together. A positive one means they move in the same direction, a negative one means opposite directions.
For risk this is critical. Two positions in related instruments are not two independent trades but one enlarged one.
The examples are obvious: ethereum follows bitcoin, gold moves against the dollar index, every dollar pair reacts to the same piece of news.
Correlations — how it is built?
Count the total risk across related instruments as a single position. If you are long bitcoin and long ethereum with 1% risk in each, the real risk is closer to 2% than to 1%.
Correlations — common mistakes
Counting risk separately for each position.
Diversifying inside a single correlation group.
Forgetting that correlations strengthen during strong moves.
Opening opposing positions in negatively correlated instruments and calling it a hedge.
Related to
Glossary
- correlation
- how closely two instruments move together. Positions in strongly correlated instruments are effectively one position of a larger size.
- instrument
- the specific thing being traded: EUR/USD, XAU/USD, BTC/USDT.
- position
- an open trade.
- Ethereum
- the second by capitalisation, a platform for smart contracts.
- Bitcoin
- the first and largest cryptocurrency by capitalisation.
- long
- buying in expectation of a rise.