Position Sizing With Correlated Trades
An account has ₹10,00,000. The trader's rule is to risk 1% per trade, or ₹10,000. Three steel stocks-A, B, and C-each offer a 5% stop distance from entry. The trader buys ₹2,00,000 of each, so total exposure is ₹6,00,000. Each position's stop is 5% below entry. Within two days, the sector falls 6% on a policy announcement and all three stops trigger at the same time, with 0.5% slippage. The trader expected the positions to be independent because they had different chart patterns and different relative-strength readings. No hedges were used, and the positions were opened on the same day. Compute the intended rupee risk per position, the actual total loss, and evaluate whether the 1% rule was followed.
1. Compute the intended risk per position and the total intended risk. Was the 1% rule followed?
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Intended risk per position = 5% × ₹2,00,000 = ₹10,000. If all three stop out, total intended risk = ₹30,000, which is 3% of ₹10,00,000. Each ticket individually follows the 1% rule, but the portfolio does not: three positions opened at once in the same sector carry correlated risk, so portfolio risk is 3%, not 1%. The trader has confused per-trade risk with portfolio risk.
2. Why is treating the three positions as independent a mistake, and what was the actual loss?
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The positions were not independent. Different chart patterns and relative-strength readings do not remove common sector exposure. A policy announcement hit all three at once, so effective diversification was close to zero. With a 5% stop plus 0.5% slippage, the loss is 5.5% × ₹2,00,000 = ₹11,000 per position, or ₹33,000 total (3.3% of the account). If the gap filled worse, say at 6.5%, the loss would be ₹39,000 (3.9%). Both exceed the intended 1% portfolio risk.
3. What position-sizing rule would cap correlated exposure?
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Treat all steel positions as one risk unit. For example, allow a maximum of 1% of the account, ₹10,000, across the sector rather than per stock. With a 5.5% stop, total position size would be ₹10,000 / 0.055 ≈ ₹1,81,818, not ₹6,00,000. Alternatively, halve size for each additional correlated position, or require a hedge. Also set an event-risk rule: reduce exposure before scheduled policy announcements and use a portfolio-level stop. The 1% rule should be applied to the risk unit, not to each ticket.