Introduction
In financial markets, different assets rarely move completely independently.
Sometimes they move together, sometimes in opposite directions.
Understanding this relationship is key to managing risk — and this is where correlation comes in.
W/H (What / Why / How)
What is Correlation?
Correlation measures how two assets move in relation to each other.
Why does it matter?
Because it directly impacts:
• diversification
• portfolio risk
• stability of returns
How does it work?
• Positive correlation → assets move in same direction
• Negative correlation → assets move in opposite direction
• No correlation → no consistent relationship
Insights from Financial Thinkers
Harry Markowitz showed that combining assets with low or negative correlation can reduce overall portfolio risk.
Simple Understanding
Think of correlation like two friends walking.
• If both walk in the same direction → positive correlation
• If one goes left and the other right → negative correlation
In markets, assets behave in a similar way.
Deeper Insight
Diversification works not just by adding more assets,
but by adding assets that behave differently.
The real benefit comes when assets do not move together.
Real Market Behaviour
During normal conditions:
• correlations vary
• diversification works well
During crises:
• correlations increase
• most assets fall together
This is why diversification sometimes fails in extreme conditions.
Practical Insight
Understanding correlation helps you:
• build better portfolios
• reduce risk
• avoid over-concentration
Concept Anchor
Correlation shows how assets move in relation to each other.
Quick Recap
• Correlation = relationship between assets
• Low correlation → better diversification
• High correlation → higher risk concentration
Closing Thought
True diversification comes not from quantity,
but from difference in behavior.
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