Stage 3: Execution and Risk · Module 8: Risk Management and Position Sizing · Lesson 8 of 9 · Back to course
You’ve sized every trade at 1%. You have three trades open. So you’re risking 3% across three separate ideas – right? Not necessarily. If those three trades depend on the same thing happening, they’re really one idea at three times the size. This lesson shows how to spot that and keep it under control.
If you haven’t yet, read currency correlations first. It explains what correlation is and how to measure it. This lesson is about what to do with it when you’re managing risk.
What you’ll learn
- How correlated trades stack up your risk
- A simple way to count your real exposure by currency or theme
- Limits that stop hidden doubling-up
- Why “hedging” with correlated pairs often just costs you twice
- Why correlations break down when you most need them
How three trades become one
Example (illustrative): £5,000 account, risking 1% (£50) per trade. You open:
- Long EUR/USD
- Long GBP/USD
- Short USD/JPY
Three different pairs. But look at the US dollar: you’re selling dollars in all three. You’ve effectively placed one large bet that the dollar will fall.
Now a strong US data release lifts the dollar sharply. All three move against you together and all three stops are hit within minutes. You lose £150 – 3% – on one piece of news. If your daily limit was 3%, your day is over before it started.
Count your exposure by currency
A quick way to see it is to write each trade as what you’re buying and selling:
| Trade | EUR | GBP | USD | JPY |
|---|---|---|---|---|
| Long EUR/USD | + | − | ||
| Long GBP/USD | + | − | ||
| Short USD/JPY | − | + | ||
| Total | +1 | +1 | −3 | +1 |
Any currency with a total of 2 or more (either way) is a concentration. Here, the USD column jumps out.
Count your exposure by theme
The same thing happens across different markets. Some common themes:
| Theme | Trades that often move together |
|---|---|
| Risk-on | Long stock indices, long AUD/JPY, long oil, short safe havens (see risk-on vs risk-off) |
| US dollar | Any pair with USD in it; gold often moves the other way to the dollar |
| Tech-heavy US stocks | Long US 500 and long US Tech 100 at the same time |
| UK domestic | GBP pairs, FTSE 250 |
Long US 500 + long US Tech 100 + long AUD/JPY might feel like three trades in three markets, but on a “risk-off” day they can all fall together. See intermarket correlations for more on these links.
Simple limits that work
You don’t need complex maths. A few written rules cover most of it:
- Total open risk cap: for example, no more than 3% of the account at risk across all open trades.
- Per-theme cap: for example, no more than 2% at risk on any single currency or theme.
- Correlated trades share the risk: if you want two highly correlated trades, split your normal risk between them (0.5% each) rather than taking 1% on both.
- Check before every new trade: “Does this add to something I already have?”
These numbers are examples, not recommendations. Set your own in your trading plan.
Using the earlier example with a 2% per-theme cap, you’d take only two of the three USD trades at 1%, or all three at about 0.67% each.
“Hedging” with correlated pairs
The opposite mistake is opening trades that cancel each other out. Long EUR/USD and long USD/CHF at the same time, for example, are often close to opposite bets, because EUR/USD and USD/CHF tend to move in opposite directions.
Result: you pay two spreads, possibly two lots of overnight financing, and you’ve taken very little real position. If you don’t have a clear view, it’s usually better to have no trade.
Correlations break down
Correlations are measured from the past and they change. Two things are worth knowing:
- They drift. A link that’s strong for months can weaken as the news focus shifts – for example from interest rates to growth.
- In a panic, many things move together. During sharp market stress, assets that usually behave differently can fall at the same time as traders cut risk everywhere. Diversification is weakest exactly when you need it most.
That’s why caps on total open risk matter more than precise correlation figures. They protect you even when the correlations surprise you.
Prop challenge angle
In a prop challenge, one correlated move can hit the daily loss limit in one go. Several open trades in the same theme at full size is one of the quickest ways to fail. The risk per trade for a prop challenge lesson shows how to cap total open risk against the firm’s daily limit.
Key takeaways
- Correlated trades are one bet at a bigger size, even when they’re in different markets.
- Count exposure by currency and by theme before each new trade.
- Use a total open risk cap and a per-theme cap, written into your plan.
- Opposite correlated trades often just cost you two sets of fees.
- Correlations change, especially in a panic. Caps protect you when the figures don’t.
Quick check
- You’re long GBP/USD and long GBP/JPY. Which currency are you most exposed to?
- Your total open risk cap is 3%. You have three trades open at 1%. Can you open another?
- Why might “diversifying” across indices not protect you on a bad day?
Answers: 1) GBP – you’re buying it twice. 2) Not under that rule, unless one closes or you reduce sizes. 3) Stock indices often fall together when markets turn risk-off.
FAQs
Do I need to calculate correlation coefficients? Not for everyday risk management. Counting exposure by currency and theme gets you most of the way. Coefficients are useful if you want to check a pair you’re unsure about.
Does this matter if I only ever have one trade open? Less, but it still applies to trades in a row. Three dollar trades one after another on the same day can hit the same news.
Is correlation the same as hedging? No. Correlation describes how things move together. Hedging is deliberately opening a position to offset another. Correlated pairs can be used to hedge, but beginners usually end up paying costs for little benefit.
Disclaimer: This page is general education, not financial or investment advice or a personal recommendation, and it doesn’t take your circumstances into account. Examples are hypothetical, for illustration only, and not an invitation to buy or sell. Learning a strategy doesn’t guarantee profits. Past performance is not a reliable guide to future results. Futures, spread bets and CFDs are complex and carry a high risk of losing money quickly because of leverage, and most retail traders lose money. With a real futures account, losses can exceed your deposit. Only trade with money you can afford to lose, and speak to an independent FCA-authorised adviser if you’re unsure. Read our full risk warning.