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Correlation

Correlation is a statistical measure that describes the relationship between the movements of two variables, often used in finance to assess how different assets move in relation to each other. Correlation is measured on a scale from -1 to +1, where +1 indicates perfect positive correlation (the assets move in the same direction), 0 indicates no correlation, and -1 indicates perfect negative correlation (the assets move in opposite directions). Understanding correlation helps investors diversify their portfolios and manage risk.

Example

If stock A and stock B have a correlation of +0.8, it means that they tend to move in the same direction, while a correlation of -0.5 suggests that they move in opposite directions half the time.

Key points

• Correlation measures the relationship between the movements of two assets.

• A correlation of +1 indicates perfect positive correlation, 0 indicates no correlation, and -1 indicates perfect negative correlation.

• Used in portfolio management to assess diversification and risk.

Quick Answers to Curious Questions

A correlation of +1 means two assets move in perfect harmony, while -1 means they move in completely opposite directions.

It helps investors understand how different assets interact, enabling better diversification and risk management.

Low or negative correlations between assets can improve diversification, reducing overall portfolio risk as not all assets move in the same direction.