Further to my previous post (refer to Position Size, EDIT), I want to expand on managing correlation in your investment/trading portfolio in order to mitigate risk. I'm going to share something new I've been working on; let's call it Chris's Correlation Model for now.I have attached a copy of the first draft. For the next version, I want to break down the cube into quadrants (maybe 18?); for example, one quadrant could be long x mid cap x early cycle. Like I said previously in Position Size , you generally don't want to risk more than 2% of your equity on any single trade. With this quadrant model, we can monitor the correlation in our portfolio and ensure that we don't have any more than 2% in a single quadrant, or essentially a single trade.
I realize that this isn't a new concept, and I admit that I am not fully versed in the ins and outs of portfolio management. Any comments/advice are welcome, or even if anyone can point to specific literature on this sort of subject - that would be very much appreciated. I would much rather adopt a tried, tested, and true model than develope my own. It's not like we're trying to re-invent the wheel here!
Note: I am aware of betas and individual stock correlation to the market. However, I didn't feel it was very suitable for any of the axes because I am looking for ways to differentiate stocks from eachother - and besides, as a trader, I think what you put on the axes is entirely subjective. Again, I'm not taking a hardline here and any advice would be more than welcome!
