Concentration Risk

Concentration risk is the danger that comes from putting too much of your money or risk into a single asset, sector, theme or market. When that one thing goes wrong, the damage is large because nothing else offsets it. Concentration can come from a single big position, from many positions that are secretly the same bet, or from a whole strategy that depends on one market condition.

Forms of concentration#

How concentration causes large losses#

Concentration also caused some of history's biggest trading disasters. Archegos Capital held very large, leveraged positions in a handful of stocks; when they fell, forced selling turned losses into a collapse. See Archegos Capital.

Measuring concentration#

• Largest position as a share of the account.
• Top five positions as a share of the account.
• Exposure by sector, theme or currency.
• Share of total risk from each position, which can differ from share of capital. A small volatile position can carry more risk than a large stable one. See Risk Contribution and Risk Decomposition.

Setting limits#

These are starting points. Concentrated strategies can work for experienced investors with deep research and a high tolerance for volatility, but the potential losses must be understood and sized.

Concentration vs conviction#

Some of the most successful investors run concentrated portfolios, and diversification can water down returns. The difference is intentional, researched concentration with clear risk limits, versus accidental concentration from many trades that turn out to be the same bet. For most traders, accidental concentration is the bigger danger. See Diversification.

Hidden concentration to watch for#

• Index funds that are themselves concentrated: cap weighted indexes can have a large share in a few companies.
• Correlated crypto holdings: most altcoins move closely with Bitcoin in sell offs.
• Employer stock plus a job at the same company: both income and savings depend on one business.
• Counterparty concentration: too much money with one platform that could fail or freeze withdrawals. See Market, Credit and Counterparty Risk.

Common mistakes#

• Letting a winning position grow into a dangerously large share without rebalancing. See Rebalancing.
• Counting positions instead of independent bets.
• Ignoring platform risk in crypto and offshore brokers.

Frequently asked questions#

What is concentration risk?#

The risk of large losses from having too much exposure to a single asset, sector, theme, strategy or provider.

How much should one position be?#

It depends on volatility and strategy, but many traders keep single positions below 5% to 20% of capital and cap risk to the stop at 0.5% to 2%.

Is diversification always better?#

Not always for returns, but it reduces the chance that one event causes a large loss. Concentration should be deliberate and sized, not accidental.

Next, learn the number that tells you if a strategy makes money: Expectancy.