correlation
A statistical measure of how two assets move in relation to each other, ranging from +1 (perfect positive correlation) to -1 (perfect negative correlation).
Example
“Stocks and bonds often have low or negative correlation — when stocks fall, bonds frequently rise, providing portfolio stability.”
Memory Tip
CORRELATION = do they move together (+1), opposite (-1), or randomly (0)? Low correlation = better diversification.
Why It Matters
Understanding correlation helps you build a diversified investment portfolio that reduces risk. By combining assets that do not move in lockstep, you can protect your overall wealth from dramatic losses when one investment type performs poorly.
Common Misconception
Many people think correlation of zero means two investments are completely unrelated, but zero correlation simply means there is no linear relationship. The investments could still move together in unpredictable ways during market stress or other unexpected events.
In Practice
If Stock A and Stock B have a correlation of 0.8, when Stock A rises 10 percent, Stock B typically rises about 8 percent. However, if you pair Stock A with Bond C that has a correlation of -0.3 to stocks, the bond tends to hold steady or gain slightly when stocks drop, helping offset portfolio losses during downturns.
Etymology
From Latin 'correlatio' (mutual relation) — how two things RELATE to each other in movement.
Common Misspellings
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Related Terms
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See Also
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