Correlation

How to spot pseudo-diversification: 3 warning signs

Diversification is supposed to combine independent bets. In crypto, it usually fails on the independence part.

• All positions point the same direction: five longs are one bet.
• Same family: several L1s, memes, or DeFi coins move in lockstep.
• Everything hangs on Bitcoin, the bellwether that pulls the alts like on a leash.
• Kovner: eight highly correlated positions are one position, eight times as large.

Why correlations jump to 1 in a crash

Correlation is not constant. In calm phases coins drift apart and the measured correlation looks harmlessly low. That is exactly what many people rely on.

Under stress it goes toward 1: panic and deleveraging sell everything at once, liquidation cascades drag every coin along. Measure your risk at the worst case, not the average.

Summing up risk: the practical rule of thumb

Add up the risk across all correlated positions and check the sum against your limit, not each position individually.

• Two bullish setups: take only the stronger one, or halve both to 0.5 percent.
• Murphy: at most 50 percent of your capital in the market at once.
• At most 20 to 25 percent in a single correlated group.
• Hite: always size relative to your capital, never as a fixed number of units.