Hidden correlation: three trades that are really one

[Fairman]

Hidden correlation: three trades that are really one

A scalper opens long EUR/USD, long GBP/USD, and short USD/CHF. On the platform, they look like three separate trades. In reality, all three are bets on the same thing: a weaker dollar. If the dollar rallies, all three lose together.

Concurrent positions in correlated pairs multiply risk. A 1 percent risk per trade becomes a 3 percent risk on a single factor.

The solution is tracking exposure by currency instead of by pair. Calculate net exposure to each currency across all open positions. Many platforms and spreadsheets can do this, and it takes minutes to set up.

Set limits on net exposure to any single currency, and treat correlated trades as one when applying risk limits.

During news, correlation tends to rise, so the hidden risk grows when it matters most.

Reviewing the log for times when multiple trades lost simultaneously often exposes a pattern of overlapping exposure.

How is currency-level exposure tracked when several pairs are open at once?

[Fairman]

The spreadsheet I use converts each position into currency exposure. Long 1 lot EUR/USD is plus 100,000 EUR and minus about 108,000 USD at 1.08. Short 1 lot USD/CHF is minus 100,000 USD and plus CHF. Add the columns and you see the net dollar exposure in one cell. When it goes beyond the equivalent of about 1.5 lots on one currency, I don't take another trade on that currency. It takes two minutes to update. It's not fancy, but it's caught me a few times when I was about to stack a fourth dollar trade without noticing.

[Amanhasnoname]

The trade that taught me about this was a Thursday where I had short USD/JPY, long AUD/USD and long NZD/USD, each at half a percent risk. They looked like three tidy unrelated setups from three different charts. A hawkish comment from a Fed speaker hit in the afternoon, the dollar jumped in about two minutes, and all three stops went within the same candle. That was one and a half percent gone in a single move that I had thought of as three separate half percents.

I now sort my open trades by the currency they're really about. Anything involving the dollar counts against one shared dollar budget of one percent total risk, no matter how many pairs it's spread over. If I want a second idea in the same direction, I cut both positions to half size instead of adding a full-sized one.

It did cost me some profit on days when the dollar trended and I could have been in with more size, but I'd take that over the days when everything stops out together.