Don't make the same bet twice

Two bets that are really one

Correlation is how much two things move together.

• Move together: when one goes up, the other usually goes up too. Like umbrellas and raincoats: on a rainy day, both sell more.
• Move opposite: when one goes up, the other tends to go down. Like umbrellas and sunglasses.
• No connection: one tells you nothing about the other. Like umbrellas and pencils.

Why it matters in trading

Say you have a $10,000 account and you risk 1% ($100) per trade. At the same time, you buy:

• NQ, the Nasdaq futures, risking $100
• ES, the S&P 500 futures, risking $100
• Shares of a big tech company, risking $100

That sounds like three careful trades. But all three mostly follow the same big US companies. If the stock market drops hard, all three will probably hit their stops at the same time.

You didn't take three 1% risks. You took one 3% bet on "stocks go up."

On the left, NQ and ES trace almost the same path. On the right, the dashed market goes its own way.

Remember the egg basket

You learned about diversification: not putting all your eggs in one basket. Owning ten tech stocks isn't ten baskets. It's one basket with ten eggs, and they can all crack together.

Things change in a panic

Here's the sneaky part. Things that usually don't move together often start moving together when markets get scared. In a big sell-off, lots of people sell everything at once to raise cash. So the protection you thought you had can shrink right when you need it most.

How traders handle it

• Add it all up. Before a new trade, ask: "If this trade and all my other open trades lose at the same time, how much is that?" Many traders keep that total under a limit, like 3% of the account.
• Pick one. If you like NQ and ES for the same reason, take the trade in one of them, not both.
• Look for truly different ideas. Two trades with different reasons in different markets spread risk better than two copies of one idea.
• Watch for trades that cancel out. Buying NQ and selling ES at the same time mostly cancels itself. You pay fees for almost nothing.

What goes wrong

• Thinking "I only risk 1% per trade" while five trades that move together are open.
• Assuming things that didn't move together last month won't move together tomorrow.

Remember

• Correlation is how much two things move together.
• Several trades on things that move together are really one bigger bet.
• Add up the risk of everything that could lose at the same time.
• In a panic, more things fall together than usual.