Concentration risk
What happens when most of a portfolio's risk sits in a single asset or a single idea?
In plain words
Concentration risk is the exposure that comes from placing most of one's risk in one asset, sector or idea. When that one bet moves against the holder, the whole portfolio moves with it, because nothing else in the holdings is independent enough to offset it.
Why it matters
Diversification only reduces risk when holdings do not move together. If a portfolio holds several assets that all respond to the same forces, holding more of them adds names but not protection. Sizing decisions and stress tests therefore need to account for how correlated the holdings actually are, not how many there are.
In a real week: BTC, week of 9 May 2022
In the week of 9 May 2022, BTC fell 7.96%, on top of four straight down weeks of -5.88%, -0.57%, -2.49% and -11.52%, leaving it 54.35% below its 52-week high. A second holding did not offset this: ETH's weekly return was 6.9 percentage points worse than BTC's, in the same direction, with an hourly correlation of 0.96, labelled very close. The two losses were not offsetting each other.
A common mistake
Counting holdings instead of measuring correlation. Several assets that fall together are effectively one position, so apparent diversification can hide unchanged risk.