Multiple Positions: Adding Up Total Risk
Risk 1% per trade and hold 8 at once, and that's 8%. If those positions are highly correlated, they'll hit their stops together: diversified on the surface, one big position underneath.
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Text version · Risk Management & Trading Psychology, lesson 9: “Multiple Positions: Adding Up Total Risk”
Risk 1% per trade and hold 8 at once, and that's 8%. If those positions are highly correlated, they'll hit their stops together: diversified on the surface, one big position underneath.
Add up all the stops
Risking only 1% per trade, holding 8 trades at once is 8%. portfolio heat is the total loss if every stop is hit at the same time; a common practice is to cap it, for example at 6% of the account.
Correlation makes risks clump together
Five semiconductor stocks have a high correlation: one bad piece of industry news and they all fall and hit their stops together. It looks like 5 trades, but it's close to one position 5 times as big.
Effective number of bets
effective number of bets = number of trades ÷ [1 + (number of trades − 1) × correlation]. Five trades with a correlation of 0.8 are worth only about 1.2 independent bets; only at a correlation of 0 are they truly 5.
Key takeaways
- Portfolio heat = the total loss if every position hits its stop at once. A common approach is to cap it, e.g. at 6% of the account.
- The higher the correlation, the more likely positions lose together: 5 highly correlated positions behave almost like 1 position 5 times as big.
- Effective number of bets = number of positions ÷ [1 + (number of positions − 1) × correlation], a measure of how diversified you really are.
- Positions in the same sector, direction or theme should be added together when counting risk.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Default “Cross-market mix”: what's the total risk? The effective number of bets? The chance of all 5 being stopped out?
- Switch to “Same sector”: the number of trades and the risk per trade haven't changed, so what's the chance of every stop being hit now? And the effective number of bets?
- Switch to “All-in bets”: what's the total risk? What's the chance of losing more than 5% in a round?
- Go back to “Cross-market mix” and raise the number of trades to 7: does total risk exceed 6%? How low does the risk per trade need to go to get back under the cap?
Quiz and explanations
- 1. You hold 6 positions at once, each risking 1.5%. How much do you lose if they all hit their stops?
- Answer: 9%.6 × 1.5% = 9%, already above the 6% cap many traders use.
- 2. 5 positions each have a pairwise correlation of 0.8. Roughly what's the effective number of bets?
- Answer: About 1.2.5 ÷ (1 + 4 × 0.8) = 5 ÷ 4.2 ≈ 1.2: almost the same as one big position.
- 3. Which set of positions spreads risk the most?
- Answer: One position each in gold, Treasuries, a stock index and crude oil.Different assets have low correlation with each other, so they're less likely to hit their stops at the same time.
Terms in this lesson
- correlation (Correlation): How much two prices move together, from −1 to 1; the closer to 1, the more in sync.
- effective number of bets (Effective Number of Bets): How many uncorrelated bets a set of positions is really worth after accounting for correlation; n equal positions with pairwise correlation ρ are about n ÷ [1 + (n − 1) × ρ] bets.
- portfolio heat (Portfolio Heat): The total loss, as a share of the account, if every position hit its stop-loss at once; for example, 6 positions risking 1% each is 6% heat.
- risk per trade (Risk per Trade): How much you're willing to lose if a trade hits its stop-loss, usually 0.5%–2% of the account.