Summary: - The episode explains Hidden Correlation in copy trading: duplicating several traders can unintentionally duplicate the same risk, making a diversified portfolio behave like a single bet, especially during market stress. - Hidden correlation types: - Asset correlation: traders end up trading the same instruments. - Factor correlation: different assets depend on the same macro drivers (e.g., dollar strength, interest rates). - Time correlation: similar trading schedules react to news together. - Style correlation: similar trading styles (trend-following or mean reversion) amplify shared signals. - Core idea: true diversification means mixing different sources of risk, not just more traders. - Five-step method to detect/reduce hidden correlation: 1) Exposure snapshot: map traders’ main markets, directions, horizons, leverage, and base currency. 2) Instrument overlap: check overlap in assets; if half or more overlap, reduce either or both positions. 3) Return correlation: compute correlations of traders’ returns; >0.7 suggests duplicated exposure; consider rank correlation for robustness. 4) Risk-based weights: allocate by risk contribution rather than equal capital; dampen weights for highly correlated traders to push average correlation toward 0.5 or less. 5) DIY stress tests: simulate plausible moves (oil, rates, dollar moves) to assess total portfolio impact; similar outcomes across scenarios indicate monoculture. - Important considerations: - Base currency can inflate correlations; include traders with different currency logic or hedging. - Common mistakes: chasing top performers by rank, mixing only one style, equal-weighting, ignoring the economic calendar. - 15-minute mini-plan to improve today: - 5 minutes: list traders and color-code main assets/factors. - 5 minutes: download recent returns and compute correlations; keep pairs below 0.5; review above 0.7. - 5 minutes: rebalance to risk parity; add loss limits per trader and overall portfolio loss limit. - Key question: will a central bank surprise affect all parts of the portfolio similarly, or will different components react differently? - Practical tips for better diversification: - Time diversification: mix very short-term with longer horizons. - Asset/factor diversification: combine currencies, indices, commodities, crypto with different engines (growth, value, rate sensitivity). - Geographic/time-zone diversification: include traders from Asian/European sessions if US-dominated. - Light humor and closing takeaway: - Diversification without checking correlation is like carrying two identical umbrellas in a storm. - Three actionable takeaways: measure correlation, weight by risk, and test across scenarios. - Call to action: subscribe, share feedback, and contact the author for strategies (links referenced in the episode). Remeber you can contact me at [email protected]