Drawdown, correlation and leverage
Three forces that make portfolios riskier than individual charts suggest.
Risk is not a collection of independent stop distances. Drawdown compounds asymmetrically, positions can share hidden drivers, and leverage converts small underlying moves into large account moves.
Drawdown asymmetry
A 20 percent loss requires a 25 percent gain to recover. A 50 percent loss requires a 100 percent gain. As drawdown deepens, recovery becomes mathematically harder.
Correlation under stress
Positions that appear diversified can respond to the same growth, rate, currency or liquidity factor. Correlations can rise during stress, exactly when diversification is expected to help.
Leverage
Leverage means exposure exceeds committed capital. It magnifies gains and losses and can force liquidation. Maximum available leverage is a provider limit, not a sensible target.
The lesson in three lines.
- 1Deeper drawdowns require disproportionately larger recoveries.
- 2Map common drivers across positions.
- 3Available leverage is not risk capacity.