Mechanism
In calm regimes, assets can appear uncorrelated. In crisis regimes, correlation tends to rise because participants sell what they can, not what they want.
Funding stress forces de-risking. Levered players reduce positions across the board. Risk models tighten. Margin requirements rise. Liquidity retreats.
The result: many assets move together, especially on the way down.
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
Portfolio looks diversified → shock hits → correlations converge → multiple positions lose together → margin usage spikes → forced selling → worse prices → deeper drawdown → strategy abandonment.
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
Diversify by drivers, not tickers. Stress-test crisis correlations.
Keep “liquidity reserves”: cash + low-leverage exposure.
Assume your best hedge may fail in the exact moment you want it.
Rule that survives:
- Write the trigger in observable terms.
- Write the action in one sentence.
- Write the penalty for breaking it.
Example archetype
You hold several ‘different’ positions that are all secretly risk-on. When a shock hits, everything sells together. Your ‘diversification’ was just multiple expressions of the same bet.
Tell: if your rule isn’t enforceable, it’s a suggestion. Suggestions don’t survive stress.
Deep dive
Driver-based diversification
Ask: what is the position’s true driver? Rates, growth, inflation, liquidity, USD funding, volatility? If drivers overlap, you are concentrated.
What survives
Lower leverage, fewer correlated bets, and explicit stress assumptions.
Related: Liquidity is there until you need it and The one bad day problem.
Glossary: correlation, tail risk.
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.