Correlated positions and max open risk

Per-trade risk is the easy part. The swing trader's real exposure is the sum of every open stop, and the real problem is that those stops do not fire independently. Five 1% positions in the same sector are not five separate 1% risks; they are one 5% bet on the sector with extra commission. This lesson defines the two numbers that keep the book honest: correlated risk and total open risk, together called portfolio heat.

Total open risk (heat)

Add up the distance from current price to current stop, in dollars, across every open position. That is what the market can take from you if every stop fires at its price, before any gaps.

On a $25,000 account, $530 is 2.1% heat.

The playbook's heat limits:

A new trade may be opened only if its risk plus current heat stays under the limit. If you are at 4.5% heat in a green week and the next trade needs 1%, you either skip it or close something. Positions with stops at break-even or better contribute zero to heat, which is a strong incentive to take partials and tighten trails: it frees room for the next setup.

Correlated positions

Two positions are correlated for this purpose if the same news would move them the same direction on the same day. In practice that means:

• Same sector or industry.
• Same theme (rate-sensitive, dollar-sensitive, commodity-linked).
• Same underlying in different wrappers (a stock and its call options; BTC and an altcoin; an index future and an index ETF).

The rule: treat all correlated positions as one trade for heat purposes, and cap that group at 2% of the account in green, 1% in amber.

Three semiconductor names at 1% each are 3% in one bet. In a green week, that is over the 2% group cap: cut one, or take the three at 0.67% each.

Uncorrelated book                  Correlated book
                                   
 Tech 1%   Energy 1%                Chip A 1%  Chip B 1%  Chip C 1%
 Health 1% Industrial 1%            
                                    same news, same day, same direction
 four bets, 4% heat                 one bet, 3% heat, disguised as three

Why correlation is the swing trader's specific problem

A day trader closes everything by 4 pm and starts fresh. A swing trader carries the book overnight, and the overnight events that gap stocks (macro data, sector news, index selloffs) are exactly the ones that hit correlated positions together. A 3% gap down across a sector on a downgrade turns three planned 1R losses into three 2R losses at once. The heat number was 3%; the actual loss was 6%.

The regime and sector-rotation work in Module 2 makes this worse if you are not careful: trading only the top four sectors concentrates the book by design. The correlated-group cap is the counterweight.

Key idea: Heat is the sum of open risk across the book; keep it under 5% in green, 3% in amber, 1.5% in red. Correlated positions count as one trade and that trade is capped at 2%.

Counting positions

Heat and correlation together imply a natural limit on how many positions a swing trader can hold: at 1% per trade and 5% max heat, five fresh positions is the ceiling, rising as partials move stops to break-even. Most swing traders do better with four to eight positions than with fifteen. Beyond eight, the nightly check runs over 15 minutes and something gets missed.

A heat sheet

Keep a one-line-per-position sheet updated nightly: ticker, shares, entry, current stop, open risk in dollars, sector, group. Sum the risk column; sum by group. Two numbers, two limits. It takes three minutes and it is the difference between knowing your exposure and guessing it.

The sheet also shows you the state of the book at a glance. A sheet full of break-even stops is a book that has earned the right to add. A sheet full of full-risk positions in the same sector is a book that is one headline from a bad week.

Try it: Build the heat sheet for your current positions, or for a hypothetical book of five. Sum the open risk and express it as a percentage of the account. Group by sector and check each group against the 2% cap. If either limit is breached, decide which position you would cut and why.

Recap

• Heat is the sum of open risk (price to stop) across all positions; cap it at 5% green, 3% amber, 1.5% red.
• Break-even stops contribute zero heat; partials and trails free room for new trades.
• Correlated positions (same sector, theme or underlying) count as one trade, capped at 2% in green and 1% in amber.
• Overnight gaps hit correlated positions together, which is why the swing trader needs this rule more than a day trader.
• Four to eight positions is the working range; keep a nightly heat sheet.