Diversification

A property of a group of positions rather than of any one of them. When results move independently, some are producing gains while others produce losses, and the combined figure swings less than the individual figures do. The effect is arithmetic and it is one of the few in markets that is not disputed.

The mechanism is correlation, not the number of positions, and this is where the idea is most often misapplied. A dozen contracts on different technology shares are largely one position wearing twelve names, because the thing that moves them moves them together. So are long positions in several commodity currencies at once. Counting positions measures nothing; what has to be examined is what they have in common.

Two limits are structural. Diversification reduces the risk specific to one company or one market, and it cannot reduce the risk common to all of them, which is why a broad decline takes everything down at once. And measured correlations are not stable: in stressed conditions relationships that looked independent for years converge, so the protection thins exactly when it was being relied on. Whether that convergence can be planned around, or only survived, is genuinely argued.