1
Concentration
A large share of equity or risk is committed to one asset, sector, direction, or event.
Lesson · Trading Risk Management
Correlation, Concentration, and Portfolio Exposure
Measure how positions that share sector, market, or factor exposure can behave like one oversized trade during stress.
Core concepts
What to understand
Keep the process direct: define the risk, calculate it, and enforce the limit.
2
Correlation
Positions tend to move together, especially during broad market stress.
3
Portfolio heat
The combined planned loss across active positions, adjusted for overlapping exposure.
Interactive lab
Change the risk conditions
Adjust the controls and read the market behavior and account impact after each change.
Correlation, Concentration, and Portfolio Exposure Lab
Synthetic educational data · no live market connection
RISK MODEL
Risk process
Apply it in order
Risk calculations should happen before the order is submitted.
Group shared drivers
Identify sector, index, currency, rate, volatility, and event dependencies.
Stress positions together
Do not assume historical low correlation will hold during a shock.
Cap combined risk
Reduce quantity or choose fewer trades when exposures overlap.
Knowledge check
Check your understanding
Select one answer for each question. Feedback appears immediately.
1. Three long semiconductor stocks are best viewed as:
They can respond to the same sector and market factors.
2. Does diversification guarantee no loss?
Diversification can reduce some concentration risk but cannot remove broad market loss.
3. What is portfolio heat?
Portfolio heat summarizes how much account equity is exposed to active stops.
4. Three positions each carry a $400 planned loss to their stops. A sector gap opens each of them 2.5 stop-distances below entry. Loss against the $1,200 of portfolio heat?
Each position loses 2.5 × $400 = $1,000; three that share the driver lose it together: $3,000, two and a half times the heat. Gap, Slippage, Liquidity, and Execution Risk’s slippage reserve is per position; the multiple across positions is what the correlation cap limits.
Practical rules
- Group positions by common risk driver.
- Cap total directional and sector exposure.
- Stress correlations higher during market shocks.
Common mistakes
- Counting tickers instead of risk factors.
- Assuming historical correlation is fixed.
- Ignoring options exposure to the same underlying or index.
References
Official reading
The labs use simplified synthetic examples. These sources cover the underlying risk and execution concepts.
Investor.gov · Asset Allocation and Diversification
Diversification spreads investments to reduce risk but does not guarantee against loss.
FINRA · Asset Allocation and Diversification
Risk tolerance and investment horizon affect portfolio allocation.