Mechanism
Correlations are not constants. They jump in stress because the same constraint drives everything: funding, deleveraging, and risk limits. When that happens, your portfolio collapses into a single factor (often USD, liquidity, or “risk”).
Process upgrade: turn this truth into a rule you can actually enforce. If the rule can’t be enforced, it will be broken under stress.
- Write the trigger condition in observable terms.
- Write the action in one sentence.
- Write the penalty for breaking it.
How it kills accounts
You add positions because each one looked fine alone. Then one macro move hits and everything loses together. Stops fire simultaneously, spreads widen, margin usage spikes, and you get forced into the worst possible exits.
How it kills accounts:
- The rule exists only in your head.
- Stress arrives and you improvise.
- Improvisation becomes inconsistency.
- Inconsistency becomes random results.
- Random results become a slow bleed.
Rule that survives
Size assuming worst-case correlation during stress, not average correlation during calm. Treat positions that share the same “risk story” as one exposure. If you want diversification, diversify the failure modes, not the tickers.
Rule that survives:
- Write the trigger in observable terms.
- Write the action in one sentence.
- Write the penalty for breaking it.
Example archetype
Long risk-on FX pairs + long high beta equities + long crypto. Three screens. One bet.
Tell: if your rule isn’t enforceable, it’s a suggestion. Suggestions don’t survive stress.
Deep dive
Quick test: ask what would make all positions lose at the same time. If the answer is “a stronger USD” or “a liquidity shock”, you’re not diversified.
Glossary: correlation breakdown, margin closeout.
Field checklist
- Write the rule in observable terms: if X, then Y.
- Remove choices under stress. Choices become rationalizations.
- Track the precursor: what state were you in before the mistake?
- Make deviations costly (size down, pause, review).
- Turn lessons into gates, not notes.