Money management risk

Money management risk is a complex topic, and today I only want to talk about portfolio risk.

We clarified in an earlier post that it is principle-based not to trade larger than 2% maximum risk per trade due to the fact of a counterintuitive principle that a 50% loss requires a 100% return to get back to break even and a 90% drop in your equity curve would mean you need to have a 999% return to start back to your initial investment.

In addition, we have mathematical certainty that you will have in a thousand sample size a chain of 13 losing trades in a row, and since we decided that a 27% maximum drawdown is the max acceptable risk to be able to recover from, which results in our 2% per trade to end up with a max -26% risk.

But there is one caveat.

Trade relation.

These 2% drop massively down at times when there is a higher correlation between your trades in your portfolio.

My recent studies of overall inter-market relations show that we are peaking in a correlation pattern (typical of near and after blow-off tops and near and after market bottoms). Meaning right now, a typical portfolio is highly correlated within itself.

Henceforth risk for most is through the roof.

Saturation at extremes stems from two origins. One is news in relation to price, and the other is the percentage of how many people are already in the market, regardless of news items.

It is this push and pull of discontinuation that also supports a possible correlation which, in effect, can cause contrarian moves much more dangerous since there might be portfolio risk exposure not fully integrated with one's system approach.

The cure is size reduction and integrating noncorrelated positions into one's portfolio.