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).

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