Portfolio Heat Management: Never Risk More Than X%
Individual position sizing isn't enough. Portfolio heat measures total risk across all positions. Learn to manage correlated risk and avoid catastrophic drawdowns.
The Hidden Risk
You risk 2% on NVDA, 2% on AMD, 2% on AVGO. You think you're risking 6%. But these are all semiconductors. When the sector sells off, you're actually risking 6% on ONE bet. This is portfolio heat.
What Is Portfolio Heat?
Portfolio Heat: The total amount of capital at risk across all open positions, adjusted for correlation.
Simple Example:
- • Position 1: NVDA, 2% risk
- • Position 2: AMD, 2% risk
- • Position 3: TSM, 2% risk
- • Naive calculation: 6% total risk
- • Actual risk: ~5.5% (these move together 90% of the time)
If semiconductors sell off 5%, all three positions hit stops simultaneously
The Portfolio Heat Formula
Portfolio Heat = Σ (Position Risk × Correlation Factor)
Correlation Factors
| Relationship | Correlation | Factor |
|---|---|---|
| Same stock | 100% | 1.0 |
| Same sector (NVDA/AMD) | 85-95% | 0.9 |
| Related sectors (Tech/Comm) | 60-75% | 0.7 |
| Different sectors (Tech/Healthcare) | 30-50% | 0.4 |
| Uncorrelated (Tech/Utilities) | 0-20% | 0.1 |
Real Example: The Semiconductor Trap
January 2026: Trader Takes 4 "Diversified" Positions
- • NVDA: 2% risk ($500)
- • AMD: 2% risk ($500)
- • AVGO: 2% risk ($500)
- • KLAC: 2% risk ($500)
- • Perceived risk: 8% ($2,000)
What Actually Happened:
Semiconductor sector sold off 6% in one day on export restriction news
- • NVDA: -6.2% → Stop hit, -$500
- • AMD: -7.1% → Stop hit, -$500
- • AVGO: -5.8% → Stop hit, -$500
- • KLAC: -6.5% → Stop hit, -$500
- • Total loss: -$2,000 (8% of account in ONE day)
All 4 positions were essentially ONE bet on semiconductors
Correct Portfolio Heat Calculation:
NVDA (2% × 1.0) + AMD (2% × 0.9) + AVGO (2% × 0.9) + KLAC (2% × 0.9) = 7.4% actual risk
Should have limited to 2-3 semiconductor positions max
Portfolio Heat Rules
Rule 1: Never Exceed 10% Total Heat
Even with perfect diversification, never risk more than 10% of your account across all positions. 6-8% is safer.
Rule 2: Max 6% Per Sector
Limit exposure to any single sector to 6% total risk. If you have 2% on NVDA and 2% on AMD, you can only add 2% more in semiconductors.
Rule 3: Diversify Across 3+ Sectors
Spread risk across at least 3 different sectors. Tech + Healthcare + Energy is better than Tech + Tech + Tech.
Rule 4: Reduce Size in Correlated Positions
If you already have 2% on NVDA, your next semiconductor position should be 1.5% or less.
Portfolio Heat Calculator
Example Portfolio Analysis
| Position | Sector | Risk | Correlation | Adjusted Risk |
|---|---|---|---|---|
| NVDA | Tech | 2.0% | 1.0 | 2.0% |
| META | Comm | 2.0% | 0.7 | 1.4% |
| UNH | Healthcare | 2.0% | 0.4 | 0.8% |
| XLE | Energy | 1.5% | 0.3 | 0.5% |
| Total Portfolio Heat | 7.5% | - | 4.7% | |
This portfolio has good diversification. Actual risk (4.7%) is much lower than naive calculation (7.5%).
When to Reduce Heat
Reduce Position Sizes When:
- • Portfolio heat exceeds 8%
- • You have 3+ positions in the same sector
- • Market volatility (VIX) is elevated
- • You've had 2+ losing days in a row
- • Major economic events coming (FOMC, CPI, etc)
The Bottom Line
Position sizing protects you from individual trade risk. Portfolio heat management protects you from correlated risk. Both are essential. A 2% loss on one position is manageable. An 8% loss because all your positions moved together is catastrophic.
Manage the portfolio, not just the positions.
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