Why Diversify?

Diversification reduces portfolio drawdowns and smooths the equity curve by avoiding concentration in a single driver (e.g., USD strength). The goal is to combine positions whose outcomes aren’t highly correlated so losses in one area may be offset elsewhere.

Instruments & Risk Buckets

Think in risk buckets rather than just symbols. Examples:

• FX — USD bucket: EUR/USD, GBP/USD, AUD/USD, NZD/USD (all largely USD‑driven)
• FX — JPY bucket: USD/JPY, EUR/JPY, GBP/JPY
• Commodities: Gold (XAUUSD), WTI/Brent, Copper
• Indices: S&P 500, DAX, FTSE, Nikkei
• Rates: US10Y, Bund futures (if available)
• Crypto (high beta): BTC, ETH (higher volatility)

Correlation — Don’t Double Count Risk

Correlation (ρ) measures how two return series move together (−1 to +1). High positive ρ means poor diversification. Estimate correlation using at least 60–120 recent sessions per timeframe.

USD Exposure & Netting Across Pairs

Sum your effective USD bet. Example: Short EUR/USD (long USD) + Short GBP/USD (long USD) + Long USD/JPY (long USD) → heavily long USD. This is not three independent trades — it’s one macro view tripled.

• Set a max USD exposure (e.g., ≤ 2R total open across USD‑long or USD‑short).
• Prefer mixing with non‑USD drivers (e.g., XAUUSD driven by real rates/risk, indices by earnings/liquidity).

Volatility‑Normalized Position Sizing (ATR)

To compare instruments fairly, use ATR to normalize stops and sizes. Higher‑volatility instruments get smaller sizes so each trade risks the same R.

Formula
Risk $ = Account × Risk%
Position size (lots) = Risk $ / (Stop in pips × Pip$ per lot)
Stop in pips often derived from ATR multiple (e.g., 1× or 1.5× ATR)

Portfolio‑Level Limits

• Per‑trade risk: ≤ 1% (≤ 0.5% for high beta like crypto).
• Per‑bucket risk: ≤ 2R open risk in any single bucket (USD, JPY, Metals, Indices, Crypto).
• Total open risk: ≤ 3–4R across the whole portfolio.
• Max positions: cap to maintain quality (e.g., ≤ 5 concurrent).

Worked Examples — Digit‑by‑Digit

Example A — Three FX trades with shared USD risk

Account $10,000; risk 1% per trade → 1R = $100. You plan:

• Short EUR/USD, SL 40 pips → $10/pip per lot → $400/lot risk → size = $100 / $400 = 0.25 lots.
• Short GBP/USD, SL 50 pips → $500/lot risk → size = $100 / $500 = 0.20 lots.
• Long USD/JPY, SL 30 pips → pip$ varies by quote; assume ≈ $9/pip per lot → $270/lot risk → size = $100 / $270 ≈ 0.37 lots.

All three are effectively long USD. Combined open risk = 3R = $300 but concentrated in one bucket. Apply limit: reduce sizes so USD‑bucket ≤ 2R total (e.g., cut each by 1/3 or drop one trade).

Example B — Mix FX + Gold + Index

Open risk plan: 2R USD bucket + 1R Metals + 1R Indices = 4R total cap.

• Long USD/JPY (1R), Short EUR/USD (1R)
• Long XAUUSD (1R) — ATR‑based stop sized so risk = $100
• Long S&P 500 CFD (1R) — sized by ATR/point value

Even if USD trades suffer, Gold/Index may respond differently to risk‑on/off or rates, smoothing equity.

Market Regimes & Time Diversification

Diversify across regimes (trend vs range, risk‑on vs risk‑off) and across time (entries split over sessions/days). Some strategies fare better in certain regimes; keep a playbook for each and rotate exposure.

Implementation Checklist

• Define risk buckets and max per‑bucket R.
• Compute rolling 60–120 day correlations for key pairs.
• Normalize sizes via ATR; set per‑trade and total open‑risk caps.
• Use a dashboard (sheet) listing symbol, bucket, risk, correlation, net USD exposure.
• Before adding a trade, ask: “Does this increase concentration?” If yes, reduce or choose a different instrument.

Common Mistakes

• Owning many USD pairs and believing you’re diversified.
• Equal lot sizing across assets with different volatility (creates hidden risk).
• No portfolio cap → several valid setups still exceed acceptable drawdown.
• Ignoring regime shifts (e.g., central‑bank cycle change altering correlations).

FAQ

Q: How many concurrent trades are ideal?

A: Focus on quality: 3–5 is plenty for most retail traders, provided total open risk ≤ 3–4R and per‑bucket limits are respected.

Q: What if correlations change?

A: They do. Recalculate monthly; when shocks hit (e.g., policy shifts), correlations can jump toward 1. Reduce gross exposure during uncertainty.

Q: Can diversification lower my returns?

A: It may cap peak returns but typically improves risk‑adjusted returns and survivability, which matters most long‑term.

Next Steps

Build a simple portfolio tracker: symbol → bucket → risk (R) → correlation → net USD exposure. Enforce per‑trade, per‑bucket, and total open‑risk caps. Combine with ATR‑based sizing to achieve true diversification, not just more positions.